Retirement Plans For the Self-Employed.

Take these steps to ensure your retirement security.

Self-employed individuals have been able to set up tax-deferred retirement plans since 1962, when the Self-Employed Individuals Tax Retirement Act, or "Keogh" Act, was passed by Congress. Over the last thirty years the contribution limits have gradually increased from a $2,500 per year limit to a $30,000 per year limit for some plans. Although there are a number of similarities between Keogh plans and Individual Retirement Arrangements (IRAs), there are also some important differences.

Any individual who is self-employed may set up a Keogh account for money earned from self-employment. Doctors, lawyers, shop owners, or anyone who moonlights in order to earn extra money can all be Keogh participants.

In some instances, a Keogh plan is set up by someone who has full-time employees working for him. Federal law requires that these employees be included in the retirement plan when they meet certain eligibility requirements.

The federal government has not set any minimum balance which must be deposited when a Keogh plan is established. However, banks, brokerage houses, insurance companies, mutual fund companies and other institutions which can assist in setting up Keogh plans will often set minimum opening balances for Keogh plans.

In order to take advantage of the tax benefits of a Keogh plan, the account must be established by December 31 of the year for which tax benefits are being claimed. For example, if you want to obtain the benefit of your Keogh on your 1999 taxes, it must be set up no later than December 31, 1999.

This is different from the requirement for IRAs, which can be set up until April 15 of the following year. However, contributions to both Keogh plans and IRAs can be made until April 15 of the next year.

There are three major types of Keogh plans: (1) profit-sharing plans; (2) money purchase pension plans; and (3) defined benefit pension plans.

The profit-sharing plan is the most popular Keogh plan because of its simplicity. Annual contributions of up to 20 percent of net self-employment earnings or $30,000 (whichever is less) can be made to the retirement plan. A participant can change this percentage from year to year and even opt to make no contribution at all during a given year.

The money purchase pension plan allows you to contribute a higher percentage of your earnings to your Keogh account, but that percentage cannot be changed from year to year. This feature of money purchase pension plans can be an important one, since if other employees are included in the plan you are still obligated to make the designated contribution to their accounts, even in years when your business loses money. Contributions up to the lesser of 25 percent of self-employment earnings or $30,000 can be made to a money purchase plan.

In the first two types of Keogh plans the focus is on how much money will be put into the plan on an annual basis. For this reason they are classified as defined contribution plans. Under the third type of Keogh plan, the defined benefit plan, just the opposite is considered. A participant decides how much money he wants to receive during retirement, and an actuary or Keogh specialist helps him calculate how much money must be contributed each year to meet that goal.

Under the defined benefit plan, a limit is placed on the annual income that can be received each year from the plan. The maximum annual income is the lower of the average income from the participant's three consecutive highest earning years, or a specified dollar figure which is adjusted annually for inflation. In 1998, that figure was approximately $160,000. Based on the goal set by the Keogh participant and the age at which contributions begin, it is possible that 100 percent of self-employment income may be put into the Keogh plan.

Funds from a Keogh plan cannot be withdrawn without penalty until the participant is 59 1/2 years of age. A 10 percent penalty is imposed for early withdrawals. Between the ages of 59?1/2 and 70?1/2 the participant has the option of tapping these retirement funds or letting them continue to accumulate. But once a Keogh participant reaches the age of 70?1/2, he has until April 1 of the following year to begin withdrawing retirement funds, either in a lump sum or in installments.

You may also want to consider opening what's known as a Simplified Employee Pension-Individual Retirement Arrangement (SEP-IRA). A SEP-IRA is much like a Keogh profit sharing plan, and its contribution limits are the same. With a SEP-IRA, you can contribute up to 13.04 percent of self-employment earnings, up to an annual maximum contribution of $30,000. But the SEP-IRA is far easier to administer than most Keogh plans, since it's handled like other IRAs.

You can set up a SEP-IRA at the same financial institutions that offer Keogh plans. Like other kinds of IRAs, you may begin to take withdrawals from your SEP-IRA when you reach age 59 1/2, and you must begin to withdraw funds when you reach age 70 1/2.