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.