If you are self-employed and you don't have a tax-advantaged retirement plan, your accountant has probably told you to get one started right away. The immediate reason is to reduce your tax bill, but the more important reason is so you will have some money to live on when you stop working.

If you are not doing this, you are missing a great opportunity to let the government help you by letting you use some of your income-tax liability to fund your own retirement. Yes, the government eventually will get it, but because you have the use of the money for several years, you end up with a lot more.

Last week, as part of a continuing series on retirement options for small-business owners, I

discussed Simple IRAs. This week, I will discuss a retirement plan that has been around since the late 1960s. That is when New York Congressman

Eugene Keogh

introduced the bill to create a retirement plan for the self-employed. It allows you to put away a lot more money than the simple IRA does, but it is only for unincorporated businesses. You qualify if your business is a sole proprietorship or partnership.

Here are the basics on a Keogh: You get a tax deduction for contributions to the plan and your investments grow tax-deferred. When you eventually take the money out of the plan, you will pay taxes in your ordinary tax bracket.

Before deciding to start a Keogh plan, you should do a cost/benefit analysis. Here are some things to consider when making the decision:

Estimate the amount an after-tax investment program would provide for your retirement and compare it with an estimate of what a Keogh would provide. To be realistic, make it an after-tax comparison at retirement. If you are the only one covered by the plan you will almost always come out ahead with the Keogh.

If your business has full-time employees (1,000 hours or more a year) who are at least 21 and have at least one year of service, they must be allowed to participate. That means you have to make a tax-deductible contribution for them to your plan. Depending on the number of employees, the cost of the employee benefits may exceed your tax savings. In that case, you'll have to weigh the cost against the increased employee morale, loyalty and goodwill it brings.

Be sure you have cash available outside the plan to take care of emergencies. There is a 10% federal tax penalty for money taken out of a Keogh before age 59 1/2 .

The most critical step in setting up a Keogh plan is choosing what kind of plan to use. This is where my March 29 introductory

column comes in handy.

There are two general types of Keogh plans, defined benefit and defined contribution.

A defined-benefit plan actually defines how much income you should receive from the plan at retirement. This is the more traditional kind of plan major corporations have used. The maximum retirement income currently allowed is $130,000, or 100% of average net income during the three highest-earning years, whichever is less.

This kind of plan benefits older people the most because it requires less time for the money to grow to provide the benefit. But it means annual contributions have to be significantly larger. Some self-employed individuals who have no employees often use this plan if they are over 50. Your accountant, custodian or actuary has to calculate the contributions based on

Internal Revenue Service

guidelines.

Defined-contribution plans base payouts on the amount of money contributed to the plan and its growth until retirement. There is no set amount of retirement income this plan has to provide. Keogh defined-contribution plans come in three varieties:

Money purchase:

Here, contributions are not based on profit but on a percentage of the employee's salary. The IRS provides a rather complicated formula to determine that percentage. The net effect of the formula is that you can contribute $30,000, or 20% of net income annually, whichever is less. You must contribute the same amount each year for each employee regardless of the company's earnings.

Profit-sharing plan:

You make contributions only in profitable years. You can contribute $24,000, or about 13% of net income per employee, whichever is less.

Combination plan:

You can use money-purchase and profit-sharing plans in the same Keogh. That way, only part of the Keogh has a mandatory contribution. Some contribute 13% of net income per employee, as in the profit-sharing plan, and perhaps another 7% in a money-purchase plan. Only the 7% would be mandatory. The overall limit on the combination plan is $30,000 or 20% of net income, whichever is less.

You can be the trustee of your plan, but you should keep the money with an independent custodian to give you maximum investment flexibility. Make sure the custodian is a strong financial institution. Generally, the custodian will have IRS preapproved prototype plans that you can use. If you require a tailor-made plan, you will need to get IRS approval and use an actuary, attorney or certified public accountant to do the work. You also have to file one of the 5500 series of forms each year. This is a very strict reporting requirement. The IRS penalty for failure to file is $25 a day, up to a maximum of $15,000.

To illustrate the potential power of a Keogh, assume a $5,000 annual contribution over 30 years, a 36% tax bracket and an 8% annualized return. Below is what you would end up with, compared with a non-Keogh investment growing at the same 8% annual rate.

Non-Keogh After Tax

Keogh After Tax

Keogh Advantage

$ 228,150

$ 391,507

$ 163,357

These numbers assume the entire lump sum was taken out at retirement. It could be even more favorable if withdrawals are taken over time.

Of necessity, there are a lot of details left out of this overview, so be sure to consult your financial adviser on this.

Next week, I will discuss the Simplified Employee Pension (SEP). Have a good one!

Vern Hayden is a certified financial planner in Westport, Conn. He is a financial consultant and advisory associate of Financial Network Investment Corp. He also is an owner of Hayden Financial Group. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While he cannot provide investment advice or recommendations, Hayden welcomes your feedback at

Hayden4t9@aol.com.