You know it is wise to begin saving for your retirement as soon as possible. But with so many different retirement accounts to choose from, where do you begin? If you are self-employed, or a principal in an unincorporated business, one option to consider is a Keogh plan.

A Keogh plan is a retirement plan for the self-employed professional, or the owner of an unincorporated, typically small, business and its employees. Money you place into a Keogh grows tax-free until it is withdrawn. Full-time employees must be included in a Keogh plan if they have worked for the company more than three years. You cannot take money out of your Keogh without a potential tax penalty before you turn 59½ and separate from service.

A defined benefit Keogh lets you choose the specific amount you will receive from the fund at retirement.
To reach this amount in time, a percentage of your yearly earnings based on an actuarial formula goes into the account each year. The formula uses the age (life expectancy) of the participant, estimated retirement benefit amount, and years to retirement to come up with the amount that goes into the fund each year. A defined benefit plan generally allows the business a greater current income tax deduction for older employees (and employers) because larger contributions are required to fund a specified future benefit with fewer years to retirement.

In a defined contribution Keogh plan, the amount of your retirement benefit depends on the amount of your annual contributions and the growth rate. Click here to see the maximum annual contributions allowed. Employees must receive the same percentage in their individual accounts as you put in yours.

There are two types of defined contribution Keogh plans. If contributions to the plan are to be dependent on profits, the plan may be designed as a profit sharing plan. Although the law requires that contributions be "substantial and recurring," it allows the flexibility to skip contributions entirely in a slow year. Until the Economic Growth and Tax Relief Reconciliation Act of 2001 increased the deduction limit for profit sharing plans to 25 percent of compensation of employees covered by the plan, effective in 2002, there was a lower (15 percent) deduction limit, relative to other plans. This was a drawback, and it favored the use of a money purchase plan, which allows a 25 percent deduction limit but requires contributions each and every year, in good times and bad. Now that profit-sharing plan contribution limits have been increased, there is no longer any trade-off for opting for the flexibility of the profit sharing over the money purchase plan.

A Keogh plan can set eligibility requirements, but the requirements cannot discriminate in favor of highly compensated employees. The plan can have a minimum age requirement (not to exceed 21), length of service requirement, full-time/part-time requirement (less than 1,000 hours), and vesting schedule. Ineligible employees may be excluded from the plan.

For example, a hypothetical plan may say that eligible employees must:

• Be full-time employees (1,000 hours or more per year).
• Be at least 21 years old.
• Have worked for at least one year.
• Vesting for eligible employees will be 20 percent of benefits for each year they work with 100 percent in the fifth year and thereafter.

Contributions to Keoghs must be in cash, but can be invested in a wide variety of ways, including bank accounts, stocks and bonds, mutual funds or annuities. The assets of Keogh plans are held in a trust for the beneficiaries (employees). If an employee leaves the company, he or she can roll over any vested benefits to an IRA.

Whether a small business owner chooses to set up a Keogh plan may depend upon whether the costs involved make sense both as a personnel management decision and as a personal retirement choice.

While Keoghs offer several advantages to qualified individuals, the requirements involved can be complex. Be sure you consult your attorney and tax advisor regarding the regulations governing Keogh plans before choosing one over an alternative retirement plan.

Keogh Plans and Taxes
The rules on tax deferment and when taxes must be paid on Keogh plans are very similar to those of other kinds of qualified retirement plans and individual retirement accounts.

You may defer income taxes on any money you put into a Keogh plan. The interest, dividends, and capital gains you earn on your Keogh money also grow tax-deferred.

You will pay taxes on your Keogh money when you withdraw it. You must generally begin withdrawing funds from your Keogh by April 1, following the later of the year you reach age 70 1/2 or the year you retire. The amount you are taxed depends on how you withdraw your money. Funds taken out are taxed at regular income tax rates. If you choose to take your Keogh money in one lump payment, you may be eligible for income averaging.

Contributions to a Keogh are made pre-tax, which reduces your taxable income. If you are the owner of a self-employed business, you can generally deduct the entire amount of your yearly Keogh contribution (including contributions made on your employees' behalf). If you are a partner in a self-employed business, you can deduct the amount contributed by the partnership on the partner's behalf.

Since tax advantages are a main attraction for Keogh plans, self-employed individuals and employees of small, unincorporated businesses should get to know the tax regulations governing Keoghs before embarking on one of these retirement plans.

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