Finally, let's talk about the one retirement account that's available to almost everyone, the Individual Retirement Account. The IRA was expanded in the early 1980s with great fanfare. Although IRAs subsequently took some hits in the mid 1980s, they're still important savings accounts, especially for those who have no other retirement plan.
In the early 1980s everyone with earned income could contribute the lessor of their earned income or $2,000 to an IRA and deduct that amount from their taxable income.
The Tax Reform Act of 1986, however, severely restricted the ability of people to deduct their IRA contributions from their taxable income.
If you or your spouse are covered by a retirement plan like a 401(k) or a traditional pension, you still can contribute the lessor of your earned income or $2,000 to an IRA. This part hasn't changed.
However, your ability to deduct your IRA contribution may be limited. If you're single, covered by a company plan, and your income is over $25,000, your ability to deduct all of the IRA contribution will be phased out. If you're single and make over $35,000 you can't deduct any portion of the IRA contribution.
Similar phase-out rules apply to couples covered by company plans with incomes between $40,000 and $50,000.
Again, if you have earned income, you always can make an IRA contribution. But if you already have a retirement plan and make too much money, you can't deduct your whole IRA contribution from your taxable income.
So if you're covered by a company retirement plan and can't fully deduct your IRA contribution, should you make a non-deductible contribution? A non-deductible contribution gives you tax-deferral on your future earnings, but you don't get the immediate benefit of deducting the contribution from your taxable income.
Because of the lack of immediate tax benefits, and tax complications, I'd recommend that you don't make non-deductible IRA contributions. Instead, I'd suggest you look elsewhere for simpler, better investments.
If you aren't contributing the maximum deductible amount to your 401(k) or similar plan, that's obviously the best bet. After that, you might think about paying off your mortgage or see my tape on mutual funds where I discuss another strategy.
In spite of this admittedly confusing talk about non-deductible IRAs and phase-outs of deductions, remember one thing about IRAs. All that stuff only applies to those who are covered already by a company retirement plan.
If neither you nor your spouse are covered by an company plan, you can contribute up to $2,000 to your IRA, and the entire amount is tax deductible. Period.
But how do you know if you're already covered by a plan? If you're in a 401(k) or 403(b) or SEP, you're covered. Another way to tell is to check the little box that says "retirement plan" on your W-2 form. If this box is checked, you're covered and your IRA contribution may not be fully deductible.
And as we were going to the studio with this script, Congress passed a new law permitting Medical Savings Accounts for employees of small businesses. MSAs allow you to pay for medical expenses on a tax-free basis while saving money for retirement inside a special retirement account.
If you're self-employed or work for a small company, you should look into MSAs to improve your medical coverage and save for retirement.