Retirement Plans: The Basic Rules

An easy way to start narrowing the field when choosing between retirement plans is to consider the restrictions.

IRAs, 401(k)s and Roth IRAs, though ubiquitous, are not available to everyone. Your ability to contribute to a Roth IRA is restricted by income; your ability to deduct contributions to a traditional IRA depends on whether you’re covered by another qualified retirement plan. And your ability to contribute to a 401(k) plan depends on your employer.

Here’s a rundown of who can and can’t contribute to each type of plan.

Traditional IRA: If you are offered a qualified plan at work--that’s a “defined-benefit” pension, a 401(k), a SEP-IRA or a public employee pension--your ability to deduct contributions to a traditional IRA depends on your income.

Single filers who earn less than $33,000 and married couples with joint income of less than $53,000 can fully deduct contributions to a traditional IRA in 2001. The income restrictions are adjusted annually. Once your annual income exceeds those thresholds, your ability to deduct contributions phases out until it disappears completely at $43,000 for singles and $63,000 for married couples.

If you are not covered by a qualified pension at work, you can deduct contributions to a traditional IRA no matter how much you earn.

Any wage earner can make a nondeductible contribution to a traditional IRA. However, if your contribution is not deductible, it’s smarter to invest in a Roth IRA instead.

Roth IRAs: If you earn less than $95,000 as a single person or $150,000 as a married couple, you can contribute up to $2,000 annually to a Roth IRA today. The Comprehensive Retirement Security and Pension Reform Act would allow you to contribute up to $5,000 annually. Your contribution is not tax deductible, but assuming that you follow the rules, when your money comes out of the account at retirement, the distributions are tax-free. For someone who is young and has lots of time to let compound interest work, that can be exceptionally valuable.

However, if you earn more than those income thresholds, your ability to contribute to a Roth begins to phase out and is eliminated once you earn more than $115,000 single or $160,000 married filing a joint tax return.

401(k) Plans: Your ability to contribute to a 401(k) is up to your employer. If your employer offers a plan for which you qualify, you can contribute up to $10,500 annually--or about 15% of your income, whichever is less. The proposed law would boost that limit to $15,000.