Definition: A pension plan that lets business owners contribute a certain
portion of their profits or a predetermined annual contribution to
a tax-sheltered account, where the funds grow until retirement
Keogh plans are the self-employed equivalent of corporate
retirement programs. To get a deduction for the current tax year,
the plan must be established before year's end. Once that's done,
actual contributions can be deferred until the extended due date
for that year's return.
The Keogh plan is generally attractive to businesses with
several highly paid owners and executives. Law firms and medical
practices, for example, tend to gravitate toward it. Although
anyone can establish a Keogh plan, it is best for companies with 10
employees or fewer because the funding burden is entirely on the
employer.
Keoghs can be administered as either a profit-sharing plan or a
defined benefit plan. Annual contributions to Keogh profit-sharing
plans are based on a percentage of self-employment income or
compensation and are subject to a $42,000 ceiling. A plan document
must be drafted in Year One (this may cost several hundred
dollars), and the IRS demands an annual report (which you can
probably do yourself).
A Keogh defined benefit plan is designed to deliver a targeted
annual retirement benefit, which can be as high as $170,000. Each
year's contribution must be calculated by an actuary--the exact
amount depends on your income, the target benefit, years until
retirement and anticipated investment returns. Annual actuarial
fees and the required IRS report can cost as much as several
thousand dollars. Another negative: You're locked into making the
actuarially determined contribution each year. However, if you make
good money and are over 50, a defined benefit plan may be worth all
the trouble--because it permits much bigger contributions than any
other type of program. If you're younger, go with a profit-sharing
Keogh.