A Keogh Plan is an employer-funded, tax-deferred retirement plan designed for unincorporated businesses or self-employed persons, including those who earn only part of their income from self-employment. Covered under Section 401(c) of the tax code, Keogh plans are named after Eugene Keogh, the congressman who first came up with the idea. Keogh plans feature relatively high allowable contributions—$42,000 annually as of 2006—which makes them popular among sole proprietors and small businesses with high incomes. In general, however, Keoghs are more costly to set up and administer than similar retirement programs, such as Simplified Employee Pension (SEP) plans, because they require annual preparation and filing of IRS Form 5500. This long and complicated document usually requires a small business to obtain the services of an accountant or financial advisor. In addition, financial information becomes available to the public under Keogh Plans.

As is the case with other common types of retirement programs, Keogh contributions made on employees' behalf are tax-deductible for the employer, and the funds are allowed to grow tax-deferred until the employee withdraws them upon retirement. The funds held in a Keogh may be invested in certificates of deposit, mutual funds, stocks, bonds, annuities, or some combination thereof. Withdrawals are not permitted until after the employee has reached age 59 ½, or else the amount withdrawn is subject to a 10 percent penalty in addition to regular income taxes. Usually only the employer may contribute to a Keogh plan. In addition, the employer can establish a vesting schedule through which employees gradually gain full rights to the funds in their accounts over a number of years. Keogh accounts must be opened by December 31 in order to qualify for tax deductions in a given year, but funds can be contributed until the company's tax deadline.

TYPES OF KEOGH PLANS

Keogh plans can be structured in a number of ways. Although it is possible to design a Keogh as a defined benefit plan (which determines a fixed amount of benefit to be paid upon retirement, then uses an actuarial formula to calculate the annual contribution required to provide that benefit), most Keoghs take the form of a defined contribution plan (which determines an amount of annual contribution without regard to the total benefit that will be available upon retirement). The two most common types of Keoghs are profit-sharing and money purchase plans—each of which fall under the category of defined contribution plans.

Profit-sharing Keoghs are the most flexible, allowing the employer to make larger contributions in good financial years and skip contributions in lean years. In contrast, money purchase Keoghs are highly restrictive, requiring the employer to make a mandatory annual contribution of a predetermined percentage of compensation. For this reason, many smaller businesses or those with variable levels of income shy away from this type of plan. In 2006, maximum contributions to Keogh plans, whether profit-sharing or money purchase plans, enabled the employer to contribute a maximum of $42,000, or 100 percent of compensation, whichever is small, to each employees account.

Although Keoghs give small business owners valuable tax deductions and enable them to provide a valuable benefit to their employees, the plans also have some disadvantages. Business owners who employ other people are required to fund a retirement program for non-owner employees if they establish one for themselves. But because the owner's contributions to his or her own plan are based upon the net income of the business—from which self-employment taxes and contributions to employees' retirement accounts have already been deducted—the owner's allowable contributions are reduced.

For small business owners interested in establishing additional retirement savings, tax law changes that took effect in 2002 created a new personal retirement plan option for business owners that has become very popular. This retirement savings option is only open to business owners who do not have full time employees. It is called the Self-Employed 401(k). Advantages that the Self-Employed 401(k) plan has over the Keogh plan include easier administration of the plan; higher contribution limits; provisions for "catch-up salary deferral contributions for those over the age of 50, and loan options that allow the account holder to borrow from his or her own account.

For small business owners with full time employees, the benefits of Keogh plans may still be one of the best retirement savings options. Other plans to consider include Simplified Employee Pension Plans (SEPs), Simple IRAs, and Simple 401(k)s. Small businesses that offer such plans can use them to attract potential employees and deter current employees from leaving the company to work for a larger competitor. With their high allowable contribution levels, Keogh plans also give the business owner a good opportunity to achieve a financially secure retirement.

BIBLIOGRAPHY

Reeves, Scott. "A Small Business Retirement Plan." Forbes.com. 12 September 2005.

Sifleet, Jean D. Beyond 401(k)s for Small Business Owners: A Practical Guide to Incentive, Deferred Compensation, and Retirement Plans. Wiley, 2003.

Tuckey, Steve. "Regulation Blizzard: Legislation out of Washington, often with temporary changes, is keeping small business retirement plans in flux." National Underwriter Life & Health. 1 August 2005.

U.S. Department of Labor. Employee Benefits Security Administration. "Easy Retirement Solutions for Small Business." Available from http://www.dol.gov/ebsa/publications/easy_retirement_solutions.html. Retrieved on 12 April 2006.