What are Keogh Plan Implications When Hiring First Employee(s)?

The short answer is contact your financial advisor. He or she should be able to discuss the implications for your situation.

But your question is a good question, especially for those who plan on generating a modest amount of wealth - small business scale, and desire to keep as much as possible in their pocket after taxes, while at the same time providing an attractive benefit to your employee(s). If you plan on generating extraordinary wealth like Dharmesh, then you pay people to optimize your after-tax wealth, no problem, no question.

Uninteresting answer below. But for those in the modest wealth camp and for the curious, read on.

The type of retirement plan described above is referred to by the IRS as a qualified plan. There are many types of qualified plans which vary based on the needs of the stakeholders, in this case you and to some extent your employee(s) based on the company climate and culture (ie what outcomes do you desire from your employee(s)). In the ridiculous example, your employee(s) would have substantial bargaining power, and would likely extort a defined benefit plan...err a pension. Not your case, but I present it for your consumption because learning like profit happens at the margins, and now that you are a 'we' instead of a 'me'. You need to think about them and not just you, becasue there are a wide range of options to fit you under the IRS rules.

A Keogh plan is a bit of a misnomer today. Originally it was put in place for partnerships and the self-employed who were governed under separate provisions called the Keogh. The name still sticks. Now that you are a 'we' you are going to be subject to some simple rules and tests by the IRS to determine if you are entitled to shelter your hard won winnings. In order to comply, you will want to set up some sort of defined contribution plan (do not do a pension - unless you are masochistic). These are governed by IRS code sec. 415(c). Or if you want real simple and cheap; I suggest an IRA based plan. Below is a link to a good IRS pamphlet for more details about your options.

http://www.irs.gov/pub/irs-pdf/p3998.pdf

Now I'm a real stickler about considering the 'we' equation because you need to find the right fit for you and your people. While the economic outcomes vary from plan to plan, they are marginal compared to your employee(s) productivity outcomes when comparing a bad fit vs a good fit plan. Review the options in the pamphlet, and consider the following questions with respect to you, your people, the culture and climate you have, and the one you want. Construct a table with the plan options in the rows and the stakeholders in the columns. Put pluses and minuses in each of the cells "plans vs constituents" as you read the questions. Trust your gut, and you will likely identify the plan you should set up. Next, contact your financial advisor.

Questions and perspectives:

1. Which of the following is most important?
   • Do I want to attract and retain key individuals?
   • Do I want to avoid an annual financial commitment to fund the plan?
   • Do I want to provide a tax shelter to me and other highly compensated employee(s)?
2. What are your motives for growth? Organizational vs Individual?
3. What are your motives for financial security? Organizational vs Individual?
4. What are your motives for acceptance? Do you want to be liked by EE’s? do you want to be respected by EE’s? Do you not give a hoot?
5. Typically small organizations are particularly concerned with the tax shelter for owner and key EE’s - will only grudgingly meet minimum requirements for rank and file.
6. Some organizations emphasize attracting key EE’s, but also want a cost effective system.
7. Some organizations are concerned with problems with older workers and seek to create a graceful transition out of the company. Someday this could be you.

Now consider your business model and the nature of revenues profits and cash flows.

1. What is the revenue? No growth, slow growth, fast growth? What about seasonality?
2. Do you anticipate future cash needs for a capital expansion?
3. What is your industry’s exposure to change over the next 5 years? Are you a buggy whip maker trying to make sense of the auto? Or are you’re the buggy whip and everybody else is your donkey?
4. What is your anticipated time to retire? Short medium or long?
5. What are the tax shelter needs of your EE’s?
6. By now you should have a good sense whether your decision should be tailored to you or your EE’s.
7. Now you need to get some understanding of the ages and salary levels of your EE’s. Segment your workforce accordingly; under 35, 36 to 55 and 56 and older. (These are somewhat objective for young, medium, and older) Segment highly paid vs staff pay. There are some proscribed rules and tests for this where you need to consult your financial advisor, but for simplicity if your company census is older and highly paid and they have bargaining power, you will need something more complex and tailored to them like profit sharing, 401(k), stock bonus, ESOP; and if they are younger staff with low pay and little to no bargaining power some form of an IRA like a SEP or a SIMPLE will do. A SIMPLE has one extra special benefit for younger workers in that the account may be liquidated for educational expenses for the individual.

Hope this helps you keep more of what you make while properly motivating your employee(s).

Malcolm "Mudduckk" Campbell, MBA mwmtoledo@yahoo.com