In this chapter:
Introduction
Retirement savings plans
The 401(k) plan
IRAs
Roth IRAs
The IRA decision
How your savings grow
Some (minor) drawbacks
Dividing your savings
Inflation & taxation
A newfangled pension
Questions & answers
Security and your 401(k)
The scoop on IRAs
Your savings priorities
If you're self-employed
Financial cramming
 

Contributing to an IRA

The other major type of retirement savings plan is the Individual Retirement Account, or IRA. Unlike 401(k)s, IRAs are not offered by your employer. Instead, they are private accounts set up through brokers, banks, and mutual fund companies. (I’ll go into the details of where you should set one up a little later on.)

The maximum you can contribute to an IRA is $2,000 a year, plus an additional $2,000 to your spouse’s IRA if he or she doesn’t earn any income. If you and your spouse both work, you can each contribute up to $2,000 to your own accounts. These limits apply to your total IRA contribution—whether to a traditional IRA, a Roth IRA, or any combination of IRAs. 

The different types of IRA have different advantages and disadvantages. Here is a rundown.

Traditional IRAs

At their best, traditional IRAs work much like 401(k)s. You get to subtract, or "deduct," your contribution from your income—that’s the upfront tax break. So if you earn $35,000 and contribute $1,000 to an IRA, you can subtract that $1,000 from your taxable income when you fill out your tax forms that year and pay tax as though you had earned only $34,000. 

Next, the money in your IRA grows without being taxed for many years—that’s the long-term break. Come retirement time, you’ll pay tax on all the money in your account as you withdraw it. 

Traditional IRAs that offer upfront tax breaks are known as deductible IRAs. Unfortunately, deductible IRAs are not available to everyone. Whether or not you are eligible for a deductible IRA depends on your "adjusted gross income" and whether you’re covered by an employer-sponsored retirement plan.

Here are the rules. If your employer does not offer a retirement plan, you are almost always allowed to deduct your full $2,000 contribution to a traditional IRA. There is one tricky exception: if you’re not eligible for a company retirement plan but are married to someone who is. In that case, you can make the full contribution to a deductible IRA only if your combined adjusted gross income is $150,000 or less and you and your spouse file a joint return. So if you stay home to take care of the kids, for instance, and your spouse has a retirement plan at work, you can still open a deductible IRA as long as your spouse earns $150,000 or less. 

But what if your employer does offer a retirement plan? In that case, your IRA contribution may not be fully deductible. Here are the rules. If you are eligible for an employer-sponsored retirement plan, you can deduct your full $2,000 contribution to a traditional IRA if:

• you’re single, and your adjusted gross income is $32,000 or less;

• you’re married, you file a joint tax return, and together your adjusted gross income is $52,000 or less.

Married people who file separate tax returns, no matter what their incomes, can’t claim the full deduction if they are covered by retirement plans at work. 

If you don’t qualify for a fully deductible IRA, you can still put up to $2,000 a year into a partially deductible IRA or a non-deductible IRA. To find out what part of your contribution may be deductible, consult IRS Publication 590, Individual Retirement Arrangements. You can order a copy of this publication by calling the IRS at 800-TAX-FORM, or by downloading it from the IRS Web site at www.irs.gov.

Partially deductible IRAs and non-deductible IRAs don’t offer the full $2,000 upfront tax break that makes deductible IRAs so appealing. They also require extra paperwork (you’ll have to fill out Form 8606 every year when you file your taxes). These IRAs should be considered only if you can’t qualify for a deductible IRA or a Roth IRA, and you’ve put the most you can in your company 401(k).