Self-employed persons and employees of small businesses need not skimp on retirement planning. A Keogh plan allows entrepreneurs and very small businesses to set aside funds for employee retirement purposes, provided the company isn't organized as a corporation. Two types of Keogh plans are available: a defined contribution plan, which business owners may set up fairly easily; and a defined benefit plan, which can be complex and for which set-up requires the assistance of an experienced pension specialist.

Determine the company's earned income or net business profit. This value is the net of total income less any relevant deductions and expenses. For the purpose of this calculation, assume net profit of $100,000 for tax year 2010.

Determine relative allocations to a money purchase plan and a profit sharing plan. Companies may contribute to either or both, but the total cannot exceed 25 percent of final earned income. For this calculation, assume 25.0 percent for profit sharing and 0.0 percent for a money purchase plan.

Calculate the self-employment tax deduction. If net business profit multiplied by 0.9235 is $106,800 or less, then the deduction equals 0.5 x (net profit x 0.9235) x 0.153. This yields $7,065. If the net business profit exceeds $106,800, then the deduction equals 0.5 x ((net profit x 0.9235) x 0.029 + $13,243.20).

Calculate adjusted net business profits. This consists of net profits less the tax deduction calculated in Step 3. In this scenario, the result is $92,935.

Calculate adjusted earned income. This value is the adjusted net business profits divided by the sum of 1.0 plus the combined percentages of the money purchase plan rate and the profit sharing plan rate. In this example, the adjusted earned income equals $92,935 divided by (1 + 0.25 + 0) or $74,348.

Calculate final earned income. This is the lesser of adjusted earned income, calculated in Step 5, or $245,000. In this example, the result is $74,348.

Estimate the profit sharing plan contribution. This consists of the final earned income multiplied by the contribution rate identified in Step 2. In this example, the result is $74,348 x 0.25, or $18,587.

Calculate the final estimated contribution amount by taking the lesser of Step 7 or $49,000, which is the statutory maximum contribution. In this case, the result is still $18,587.

#### Tip

- Always check current IRS regulations for contribution ceilings. For tax year 2010, for example, the statutory cap on contributions is $49,000.

#### Warnings

- Be careful with net income calculations -- some forms of income, including income from a passive partner, may be classified as investment income rather than earned income and would therefore be ineligible for inclusion in the contribution calculations.
- Keogh plans often require more paperwork than other small-business retirement plans. Carefully consider the benefits, costs and complexities of all available options before settling on a particular retirement program.

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