A new type of retirement savings plan came to market this year, promising bigger tax deductions and better benefits for many people.
It's called a "defined-benefits" Keogh plan, and it is very different from the regular Keoghs that many self-employed business and professional people have. Regular Keogh users may even want to switch to a defined-benefits plan.
First, to explain the difference between the two:
A regular Keogh stipulates an annual contribution -- up to 15 percent of earnings, with a maximum contribution of $7,500. If you have employes, you must contribute the same percentage of earnings for them as you do for yourself. At retirement, you receive whatever funds have accumulated in the plan, without knowing in advance what the final sum will be.
A defined-benefits Keogh works like a corporate pension plan. You determine in advance how large an income you want at retirement (whatever certain limits), and make whatever annual contributions are necessary to meet that goal. Every year, an actuary looks at how much money your Keogh fund has earned and calculates your next contribution -- either higher or lower than it was the year before.
Depending on your age and income, you can put as much as $11,000 into a defined-benefits Keogh the first year, which is $3,500 more than a regular Keogh allows.
Not everyone can afford Keogh plans; some persons are living right up to the edge of their incomes. Howard Phillips, president of Consulting Actuaries Inc., in West Caldwell, N.J., judges suitability this way:
If you're able to save $10,000 a year or less toward retirement, consider a regular Keogh plan, an Individual Retirement Account, or a simplified employe pension plan (a company IRA). If you can save $10,000 to $15,000 a year from net income, you probably will do better with a defined-benefits Keogh. If you are saving more than $15,000 a year from net income, consider incorporating your business and getting the even-greater deductions available to corporate pension plans.
For a 1979 tax deduction, you must set up your plan by year-end. You then have until April 15 to make the contribution. Some facts about defined-benefits Keoghs:
They're generally best for people age 40 to 60. Younger people do better with regular Keoghs, unless they have very high salaries.
They're so new that not many companies offer them yet. Look for defined-benefits plans from banks or insurance companies.
Actuaries assume that Keogh plan funds will earn 5 percent or 6 percent a year. If they earn more, your annual contribution to the plan will fall (because less money will be needed to reach your stated retirement-income goal).
The idea of reduced contributions bothers some people. So, some banks cheerfully invest your money at 5 percent or 6 percent. In effect, this keeps up your tax deduction, but deprives you of economic gains.
Phillips advises that you take the highest interest the bank allows. Assuming average 8 1/2 percent earnings, it would take 12 years before a 40-year-old man starting out with a $10,800 contribution got down to the $7,500 maximum allowed by regular Keoghs. By that time, Congress may well have changed the rules.
Many banks offer split-funded plans, putting part of your money into a bank certificate of deposit and part into life insurance. Insurance-company plans combine life insurance with annuitites or other insurance-company products.
Steven Reitman of Phoenix Mutual Life points out that if you need life insurance, buying it in a defined-benefits Keogh plan raises the maximum allowable contribution (and tax deduction) to $15,000 or so and makes your insurance premiums tax deductible. There's a tax cost on your personal tax return, but it's minor.
With defined-benefits Keoghs, companies contribute less for young, lower-wage employes than they would with regular Keoghs.
Annual, tax-deductible actuarial fees vary widely. Phillips charges a minimum of $215 for a one-person plan; Manhattan Savings Bank, $205; Phoenix Mutual, about $500.