Ask the Dollar Diva By Dorothy Rosen • Bankrate.com

A Keogh plan shelters current income

Dear Dollar Diva,
What is a Keogh plan?

A Keogh plan is a retirement plan that is available to self-employed taxpayers. It can be established by a sole-proprietorship or a partnership.

Benefits of a Keogh plan

Self-employed taxpayers can defer paying taxes on current income by making contributions to a Keogh plan. If you are self-employed and you want to contribute the maximum amount possible to a retirement plan, the Keogh plan is the way to go. But you will usually have to include your employees in any retirement plan you establish if you want to be able to deduct your own contributions.

There are two kinds of retirement plans, Defined Benefit and Defined Contribution. A Keogh can be established in either form.

Defined Benefit Plan

This type of plan is the traditional retirement plan that gives the retired person a monthly check, based on what he earned while working, and how long he was on the job. He gets a monthly check for as long as he lives. This pension is usually fully paid for by the employer, and it is becoming rare as more and more companies offer less expensive retirement alternatives to their employees.

However, as a self-employed person, you have access to a defined-benefit plan through a Keogh. It's more expensive to maintain than a defined-contribution plan because an actuary has to figure out the contribution amounts needed to pay for the specified benefits. But, if you're making a lot of money, retirement is not too far off and your goal is to defer as much current income as possible, a defined benefit Keogh is worth talking to your accountant about.

For 1999, a self-employed taxpayer can deduct the lesser of $130,000 of earned income or 100 percent of his average earned income from his three highest-income years.

Defined Contribution Plans

In a Keogh, there is no promise as to how much you will receive when you retire. Generally, the plan calls for the employer to make a certain contribution each year, based on a specific percentage of compensation.

Self-employed taxpayers most often use one of two defined-contribution plans as Keogh plans: money-purchase pension plans and profit sharing plans. The maximum contributions vary. To simplify, let's assume the taxpayer is a sole-proprietor with no employees:

• Money-purchase pension plan: The 1999 contribution is limited to the lesser of $30,000 or 20 percent of self-employment income. Once this plan is established, contributions must be made each year, whether or not there are profits.
• Profit-sharing plan: The 1999 contribution is limited to the lesser of $30,000 or 13.0435 percent of self-employment income. There is no requirement to make continuing, specific contributions to a profit-sharing plan. It is funded at the discretion of the owner.

If a self-employed taxpayer establishes both plans, the maximum total combined contribution for 1999 is the lesser of $30,000 or 20 percent of self-employment income. Talk to your accountant before you set up any kind of retirement plan.

DOROTHY ROSEN has a master's degree in finance, with a specialization in accounting, from the Kellogg Graduate School at Northwestern University in Evanston, Ill. Rosen has more than 15 years of experience in the financial arena, serving in Illinois and Florida as a certified public accountant, financial consultant, expert witness and educator. She is owner of Dorothy Rosen, CPA, a public accounting firm that serves individuals and small businesses.