A Keogh plan is a qualified tax-deferred retirement plan targeted to the self-employed. Administrative fees are generally higher on Keogh plans than on individual retirement accounts, because Keoghs are more complex. Yet Keoghs typically allow higher contribution amounts. Therefore, self-employed people who make good money often find that a Keogh’s benefits outweigh its costs. When they sell, incorporate or retire, they may choose conversion to a lower-cost IRA.
Keogh Plan Defined
A sole proprietor or partnership can establish a Keogh. It requires the participation of at least one self-employed individual. A lone partner cannot set up a Keogh. You can establish a Keogh as a defined-benefit plan or defined-contribution plan. As someone who's self-employed, you are allowed to contribute to the Keogh only if the business for which it was established has self-employment net income from your personal services.
Conversion Equals Rollover
The IRS generally treats self-employed people as employees for rollover purposes. Therefore, if you want to convert your Keogh plan to an IRA, you can roll over all or part of your eligible Keogh plan into a traditional IRA, a Roth IRA or a Simplified Employee Pension plan. This includes a lump-sum distribution. Defined-benefit and defined-contribution Keogh plans are both rollover-eligible.
With a direct rollover, you transfer the funds or assets directly from your Keogh account to your traditional IRA or SEP-IRA tax-free, or to your Roth IRA. The transfer occurs between financial institutions, without you taking possession of the money. You simply complete the paperwork authorizing the direct rollover and providing the requisite information. You can transfer all of the funds, or you can leave some of them in the Keogh account.
Indirect Rollover -- Distribution
An indirect rollover occurs when you take delivery of the funds from your Keogh before depositing them into your traditional or SEP-IRA. Unfortunately, if you take delivery, the financial institution generally must withhold 20 percent of the distributed funds. You then have 60 days from the date you receive the distribution to deposit the full amount of the distribution, pretax, into an IRA.
Indirect Rollover - Penalties
If you don't deposit the full amount of the distributed funds into an IRA during the 60-day window, the IRS will treat the funds that remained in your possession after the 60th day as a distribution subject to income taxes. If you are younger than 59 1/2, that portion of the distribution will also be subject to a 10 percent penalty for early withdrawal.
You can choose to convert your Keogh plan to a Roth IRA, or to shift a portion of your Keogh to a Roth IRA. However, the converted or distributed amount will be included in your gross income and subject to ordinary income tax. If you do a direct rollover or deposit by the 60th day, there is no 10 percent early-withdrawal penalty. Roth conversions can be useful in any year that you have zero taxable income.
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