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The M-Network is currently doing a series highlighting Dave Ramsey’s 7 Baby Steps for getting out of debt and getting your life on the right track financially. You can read about all of the steps over on Cash Money Life who kicked things off with a great introduction. As other members of the network add their articles, I’ll add links to them at the end of this post.

Dave Ramsey’s Step #4 is simply this–save 15% of your gross income for retirement, preferably in Roth 401(k) and Roth IRA retirement accounts. This step raises two important questions: (1) what’s so special about 15% as opposed to 10%, 20% or some other savings rate; and (2) why invest in after-tax Roth retirement accounts rather than pre-tax 401(k) and IRAs? To answer these questions, I’ve created some charts to show the impact of these decisions on your retirement nest egg. Following the charts, I’ll list some of the factors worth considering as you make your own retirement savings decisions.

Save 15% of Gross Income toward Retirement

Albert Einstein is said to have quipped, “compound interest is the most powerful force in the universe.” Whether he actually said this is undetermined, but to this I would add, “compound interest is the most powerful force in a retirement account.” But to unleash this force you need two things: savings and time. The more savings and time you have, the more powerful the effect of compound interest. So what does the effect of compound interest have on saving 15% of your gross income? Check out this chart showing the growth of 15% savings on a $100,000 per year salary assuming a 10% return, 3.1% inflation and savings beginning at age 30:

There are several important observations to make here. First, the ending balance of just over $2 million is in today’s dollars assuming a 3.1% inflation rate. The actual retirement savings balance after 35 years is over $6 million. Second, notice that the chart is broken into three colors: yellow, blue and purple. The yellow represents the actual amount of money invested, the blue the amount earned directly from the money invested (called simple interest), and purple the amount earned from the simple interest (called compound interest). All of these numbers are adjusted for inflation. But the point is that given enough time, the compound interest earned will far exceed the amount invested or even the simple interest. That’s the most powerful force in the known universe that Einstein was talking about! Finally, note that the $2 million balance in today’s dollars is enough to withdraw about $80,000 a year for retirement, exactly what you’d need if you were seeking to replace 80% of your income in today’s dollars (I’ve written before about the 4% withdraw rate rule for retirement accounts).

No what happens if instead of saving 15%, you save 10%? Here’s the chart:

Notice that you still get the benefit of compounding. That’s because the benefits of compounding depend on how long you invest and what return you earn. But of course, the more you invest, the more you end up with. In this case, at a 10% savings rate, you end up with about $1.3 million in today’s dollars. This is not enough to withdrawal 80% of your current pay during retirement, assuming a 4% withdrawal rate. You may get social security benefits to make up some of this shortfall, but Dave Ramsey’s view is we shouldn’t count on social security. While I’m not as pessimistic on this point as he is, ignoring social security in your retirement assumptions is certainly a conservative approach.

From this we can conclude that a 15% savings rate for retirement is a reasonable approach, given all of the assumptions we’ve made. In making your own decision on retirement savings, you may want to consider these additional factors:

• When you start saving for retirement: If you start saving for retirement at age 18, you may not need to save 15% (although it’s a good habit anyway). At age 18, you have 47 years to invest before you’re 65. At a 10% savings rate using the numbers above, your inflation adjusted balance at age 65 is more than $3 million (more than $13 million in actual dollars!). If you wait until your 40 to begin, you may need to save considerably more than 15%. At that age, a savings rate of 15% yields less than $1 million in inflation adjusted dollars, and even a 20% savings rate results in just under $1.3 million. So when it comes to retirement savings, one of the most critical success factors is to start saving as soon as you can. I should add that if you are in your 40s or older and have little retirement savings, there’s no point in beating yourself up over it. Just start saving now.
• Assuming a 10% return is generous: The above calculations assume a 10% return on investments. Change it to just 9.5% and the numbers drop considerably. Many believe that annual returns of 10% will be unrealistic in years to come. If you’re looking for predictions, you’ve come to the wrong place. But I can say that sticking your money in a money market or “safe” bond account won’t get you the returns most of us need for retirement. I’ve written extensively about asset allocation, and here are to great books that have helped me a lot in formulating my investment plan: The Bogleheads’ Guide to Investing (don’t let the goofy title of the book fool you, it’s a very good guide to investing) and All About Asset Allocation.
• Making your own calculations: You may want to make your own calculations for retirement using assumptions that are different than what I’ve used. If so, here is the investment calculator I used in this article.

Invest Retirement Savings in Roth Accounts

I believe that for most people most of the time, Roth retirement accounts are best. Why? Well, let’s first look at the numbers. As with the above calculations, let’s assume you start saving at age 30, retire at 65, invest $15,000 annually for retirement, are in the 25% tax bracket and (this is important) will be in the 25% tax bracket during retirement. Under these circumstances, which is best, a $15,000 investment in a Roth 401(k) or a traditional 401(k)?

The Roth 401(k) beats the traditional 401(k). But this test is unfair. Investing in the Roth 401(k) costs us more because we don’t get an immediate tax break like we do with a traditional 401(k). So let’s assume that we invest the tax savings we enjoy with a traditional 401(k) into a taxable investment account. Now which is best?

The traditional 401(k) balance improves, but it still doesn’t catch the Roth 401(k) balance. Why? It doesn’t catch the Roth 401(k) balance because the after-tax money invested in taxable accounts doesn’t grow tax-free like the Roth 401(k) does. The difference in these two account balances represents the taxes you pay on the earnings from your taxable account. If you could invest the tax savings from the traditional 401(k) into a Roth IRA, the two accounts balances would be identical.

Now, what if your tax rate goes down during retirement? Here is a chart assuming a 25% tax rate during your working years and a 15% tax rate during retirement:

The balances get closer, but the Roth still edges out the traditional 401(k). Why? Again, it goes back to the fact that the tax savings from the traditional 401(k) are invested in a taxable account where taxes must be paid on all earnings. And if your tax rate goes up during retirement, the choice in favor of a Roth 401(k) becomes even more clear. If you’d like to play with these numbers and assumptions yourself, here is the Roth 401(k) versus Traditional 401(k) calculator that I use.

Now, let’s put aside the numbers for a moment and consider some additional factors that are important to this decision:

• Future tax rates are unknown: The fact is we don’t know what the tax rates will be a year from now, let alone 30 years from now. Many argue that they have only one way to go–up. Maybe, although the government can increase taxes without increasing the income tax rate. For my retirement investing decisions, I make no assumptions about future tax rates. How then, you may ask, do I make a decision between Roth and traditional retirement accounts?
• You can pick both: I invest in both Roth and traditional retirement accounts. Like so much in life, this is not an all or nothing choice. Since I don’t know where tax rates will go, I invest in both. My employer matches 401(k) contributions, and these matches must go into a traditional 401(k). Thus, I’ve started increasing the portion of my contribution that goes to a Roth 401(k). My goal is to direct 100% of my contributions to my designated Roth 401(k), while the matching contributions go to a traditional 401(k).
• Roth accounts bring certainty to retirement planning: One of the things I like about Roth accounts is that you know exactly what you have saved for retirement. With traditional retirement accounts, you have to make a guesstimate about taxes to know how much money you have to fund your retirement.
• Conversion to Roth IRAs: Roth 401(k) retirement accounts can be converted to Roth IRA accounts without any tax liability. I like this feature because Roth IRAs offer a distinct advantage over deductible IRAs and 401(k)s–no required minimum distribution during retirement. You can hold onto your Roth IRA for as long as want, and it is a great way to pass on wealth to your children or grandchildren if that’s one of your goals. If you’d like to read more about this feature of retirement accounts, here are two books I own that are very good on the subject of taking your money out of retirement accounts: The Retirement Savings Time Bomb . . . and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, 401(k)s, and Other RetirementPlans from Near Annihilation by the Taxman and IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out.

The M-Network Dave Ramsey Baby-Step Series

Here are all of the articles thus far from the M-Network series:

• Overview at Cash Money Life
• Step 0 - No More Debt at Debt Free Revolution and Single Guy Money
• Step 1 - $1000.00 Emergency Fund (@Gather Little By Little)
• Step 2 - Pay off all debt using the Debt Snowball (@Paid Twice)
• Step 3 - 3 to 6 months of expenses in savings right here! (@ Being Frugal)
• Step 4 - Invest 15% of household income into Roth IRAs and pre-tax retirement (@ The Dough Roller)
• Step 5 - College funding for children (@ My Two Dollars)
• Step 6 - Pay off your mortgage (@Moolanomy)
• Step 7 - Build wealth and give! (@ Plonkee) Money
• Series Wrap Up (@ Being Frugal) and (@ Paid Twice)

As Roth IRA and Roth 401(k) retirement plans gain in popularity, unsuspecting investors may fall prey to a potentially expensive mistake. Money in a Roth 401(k) or Roth IRA account can be withdrawn tax free, assuming the withdraw meets IRS requirements. In contrast, withdrawals from traditional 401(k)s and deductible IRAs are taxed as ordinary income when when you take the money out. As a result, a dollar in a Roth account is worth a dollar at retirement, but a dollar in a traditional retirement account is worth a dollar minus the taxes you’ll pay when you withdraw the money. So what’s the potential gremlin lurking in your 401(k)? It’s treating Roth retirement savings the same as traditional retirement savings when making your investment decision. Let’s look at an example to see how this mistake could impact your investments.

After-Tax Asset Allocation–An Example

Let’s assume the following three things for our example:

1. you have $200,000 in retirement savings, $100,000 in Roth 401(k)s and Roth IRAs, and $100,000 in traditional 401(k)s and deductible IRAs;
2. You have decided to invest 50% in stock mutual funds and 50% in bond mutual funds (your asset allocation may be different, but using a 50/50 split makes this example easier to follow);
3. You will pay 25% in taxes when you withdraw funds from your traditional 401(k) and deductible IRAs during retirement.

Now with these assumptions in mind, let’s look at the following example:

You invest $100,000 in stock funds in your traditional retirement accounts; you invest the other $100,000 in bond funds in your Roth retirement accounts.

Have you achieved your desired 50/50 split between stocks and bonds? It may look like you have, but the answer is no. Why?

While your traditional retirement accounts have a balance of $100,000, you will eventually pay Uncle Sam $25,000. So after factoring in taxes, you only have $75,000 invested in stocks. In other words, what you thought was a 50/50 split between stocks and bonds actually is a 43/57 split between stocks and bonds on an after-tax basis.

Here’s a table to show you how I calculated these numbers:

After-Tax Asset Allocation in Action

So how do we fix this problem? The answer is really simple–implement your asset allocation plan based on after-tax dollars. To do this, you ‘ll need to make an estimate of what percentage of your traditional retirement accounts you’ll pay in taxes. This is very much a guestimate, particularly if you’re young, but I think a reasonable estimate can be made. I’ve chosen 25% for these examples; you may decide a different estimate is more appropriate for your situation.

Once you’ve decided on an estimate for future taxes, deduct this from your traditional account balances, and then calculate your asset allocation. In our above example, we want a 50/50 split of the after-tax balance of $175,000. This would mean that we invest $87,500 in stock funds and $87,500 in bond funds, on an after-tax basis. How do we do this? Well, since no taxes are paid on Roth retirement accounts, we could reduce the $100,000 we currently have invested in bonds in the Roth account down to $87,500. The remaining $12,500 in the Roth accounts would be allocated to stock mutual funds, as would all of the traditional retirement account investments.

At first glance this may seem odd. Under this scenario, we have a total of $112,500 in stocks. But if we subtract the $25,000 in taxes we’ll eventually pay from the traditional retirement accounts, our after tax investment in stocks hits are target asset allocation of $87,500 ($100,000 - $25,000 + $12,500).

Is life too short to worry about after-tax asset allocation?

Particularly if math was not your favorite subject, fussing with after-tax asset allocation may seem like more trouble than it’s worth. That’s my view when it comes to comparing traditional retirement accounts with my taxable accounts. I may pay slightly more in taxes on my traditional retirement accounts, but not enough to worry about, in my opinion. After state tax, my retirement accounts will get hit with about 21% in taxes. And while the initial investment is not taxed, the vast majority of what I have in taxable accounts is unrecognized capital gains. Why? Because I’m a buy and hold investor who keeps investments for decades.

But now that I’ve just started investing in a Roth 401(k), I believe that after-tax asset allocation is an important consideration. And calculating an after tax asset allocation only takes a few minutes. Here are the steps:

1. Estimate your future tax rate to be applied to your traditional retirement accounts.
2. Calculate your total after-tax retirement account balances by subtracting your estimated tax rate from your traditional retirement accounts.
3. Using the after tax balance, determine how much of each asset class you need to implement your asset allocation plan (you do have an asset allocation plan, don’t you?).
4. If the investment is held in a Roth account, the amount invested will simply be the amount calculated in step 3, because no taxes will be paid on this money when you take it out.
5. If the investment is held in a traditional retirement account, divide the amount you calculated in step 3 by the following number: 1 - your estimated tax rate.

A quick example for this last step. Let’s assume your asset allocation calls for 10% to be invested in REITs, and your total retirement funds on an after-tax basis equal $175,000. Thus, you need to invest $17,500 on an after-tax basis in REITs. If the REIT were held in a Roth account, you’d simple invest the full $17,500. But if it’s held in a traditional account, divide $17,500 by 1 - your tax rate, or in our example, 1 - 25%. Thus, we would divide $17,500 by .75, resulting in an investment of $23,333. And just to confirm that this works, you can subtract our estimated tax rate of 25% from $23,333, resulting in our after tax allocation goal of $17,500.

Some articles on after tax-asset allocation

Here are some articles on after-tax asset allocation that are worth reading if you are interested in pursuing this approach:

• An After-tax approach to allocation
• Principles of after-tax asset allocation (pdf format)
• After tax allocation tricky to calculate

The IRS each year issues a very helpful and thorough publication about Individual Retirement Accounts or IRAs. Called Publication 590, the document covers traditional IRAs, Roth IRAs, SIMPLE IRAs and other related issues. The IRS just released its 2007 edition (it comes at the end of the year). It’s available as a pdf, but be warned, it weighs in this year at a hefty 108 pages. You can download it here. It’s also available in an html version here, but I much prefer the pdf version. If you’re not interested in trudging through a 108 page tome, however, here is what’s new for 2008.

Traditional IRA contribution and deduction limit

The contribution limit to your traditional IRA for 2008 will be increased to the smaller of the following amounts:

• $5,000, or
• Your taxable compensation for the year.

Read the rest

The question of whether to invest in a Roth or traditional has come up a lot lately. Yesterday I wrote about these retirement accounts in the The Ultimate Guide to Traditional and Roth 401(k) and IRA Retirement Accounts. In that article I linked to a Roth 401(k) calculator that can help you determine what’s best for you. I wanted to point out, however, that the decision is not necessarily one or the other. If your employer offers both Roth and traditional 401(k) plans, typically you can chose to invest in both. Your total contributions cannot exceed the IRS limits ($15,500 in 2008 + $5,000 catch up for those 50 and older). But within this limit, you can invest a portion in a traditional plan and a portion in a Roth plan. I can think of at least two good reasons to consider splitting your investment into both types of plans.

First, you may conclude that the best plan for you depends on what your tax rate will be during retirement. The problem is, of course, that we can’t know for sure what the tax situation will be many years from now. Since we don’t know, why not invest some of your money in both plans? By doing so, you hedge against the possibility that you’ll put all your money in one plan that turns out to be the second best choice.

Second, you may conclude that the Roth is best, but can’t afford to lose the current tax savings that a traditional 401(k) offers. If that’s the case, you can start off investing some small portion in the Roth plan, and as your income grows (and your need for the tax deduction diminishes), you can gradually switch your contributions from the traditional plan to a Roth plan.

It’s this second option that I’m seriously considering beginning in 2008 when my employer begins offering the Roth 401(k). And since my company matches dollar for dollar up to 6%, putting all my money in a Roth 401(k) would result in the first option. Why? Because matching contributions are placed in a traditional 401(k), even if the employee contributions go to a Roth 401(k).

When it comes to boosting your retirement accounts, the IRS has sent us help in the form of tax advantaged accounts like a 401(k) and an IRA. If we don’t take full advantage of these money making tools, we are turning away help when we need it the most. In this article, I will describe the different features of roth and traditional 401(k) and roth and deductible IRA accounts. There are different types of 401(k)s and IRAs, and we’ll look at the qualification and contribution limits, withdrawal restrictions, and other features. I’ll also link to some IRS publications that provide detailed descriptions of these accounts. It’s important to note that 401(k) and IRA retirement accounts involve a lot of rules and regulations. Getting them wrong could have a major impact on your retirement savings. I am not a tax or retirement account specialist. What follows is my best understanding of the rules as they exist now, but you should consult your plan administrator or other retirement account specialist before making any decisions.

401(k)

Named after the 1978 IRS tax code provision implementing this retirement account, 401(k)s are offered by employers to certain covered employees. Both the traditional 401(k) and the Roth 401(k) allow an employee to set aside a portion of their income for retirement. The plans also permit an employer to make matching contributions if it so desires. It’s important to note that the tax advantages of a traditional 401(k) are different than for a Roth 401(k).

Traditional 401(k)

In a traditional 401(k), money contributed to the retirement account is not taxed at the time of the contribution. Instead, the pre-tax contributions and any earnings are not taxed until you withdraw the money from the account. There are three important contribution limits: (1) how much an individual may contribute; (2) how much an employer can match; (3) and the catch up contribution limit.

For both 2007 and 2008, the most an employee may contribute is $15,500. This is adjusted upward based on inflation in $500 increments, so the limit may go up in 2009. In addition, those 50 and older may make a “catch-up” contribution of up to $5,000 in 2007 and 2008. As with the regular contribution, the “catch-up” contribution is also adjusted upward in increments of $500 based on inflation.

In addition, employers may offer matching contributions. An employer’s match does not count toward an individual’s contribution limits. In other words, if your employer matches your contributions dollar for dollar up to 6% of your salary, these matching contributions do not count toward the $15,500 2007 limit. In 2007, an employer’s match cannot be based on more than a $225,000 salary, meaning that a 6% dollar for dollar match is capped at $13,500 ($225,000 * 6%). This limit goes to $230,000 in 2008.

Minimum Required Distribution (MRD): The official distribution age for 401(k) funds is 59 1/2. Subject to certain exceptions described below, withdrawing money earlier will result in a 10% penalty in addition to the income taxes you’ll have to pay. In addition, the IRS requires certain minimum distributions. Failure to abide by these rules can result in a 50% penalty tax on the portion that should have been withdrawn, so understanding the MRD is important for retirees. The MRD rules are described in an IRS 401k Resource Guide, but here are the basics. The required beginning date for distributions is April 1 of the first year after the later of the following years:

• Calendar year in which the participant reaches age 70½.
• Calendar year in which the participant retires.

A plan may, however, require that the participant begin receiving distributions by April 1 of the year after reaching age 70½, even if the participant has not retired.

If the participant is a 5% owner of the employer maintaining the plan, then the participant must begin receiving distributions by April 1 of the first year after the calendar year in which the participant reaches age 70½. You can find additional information from the IRS in Publication 575.

401(k) Hardship Withdrawals: A 401(k) plan may, but is not required to, provide for hardship distributions. If the 401(k) plan offers hardship distributions, then participants who qualify can withdrawal money from a 401(k) before reaching 59 1/2. For a withdraw to be on account of a hardship, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. The need of the employee includes the need of the employee’s spouse or dependent. Whether a financial need is immediate and heavy will depend on the facts and circumstances of each situation, but the IRS has defined certain expenses as qualifying under this definition:

1. certain medical expenses
2. costs relating to the purchase of a principal residence
3. tuition and related educational fees and expenses
4. payments necessary to prevent eviction from, or foreclosure on, a principal residence
5. burial or funeral expenses; and
6. certain expenses for the repair of damage to the employee’s principal residence

It’s important to note that a distribution is not considered a hardship if an employee has other resources that can meet the financial need. Here’s how the IRS describes this point:

A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee’s spouse and minor children. Whether other resources are available is determined based on facts and circumstances. Thus, for example, a vacation home owned by the employee and the employee’s spouse generally is considered a resource of the employee, while property held for the employee’s child under an irrevocable trust or under the Uniform Gifts to Minors Act is not considered a resource of the employee. (Reg. §1.401(k)-1(d)(3)(iv)(B))

A hardship withdrawal is subject to a 10% penalty plus tax. There are certain circumstances when a penalty-free withdrawal can be made, which include withdrawals:

• Made to a beneficiary (or to the estate of the participant) on or after the death of the participant.
• Made because the participant has a qualifying disability.
• Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the participant or the joint lives or life expectancies of the participant and his or her designated beneficiary. (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 59½, whichever is the longer period.)
• Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55.
• Made to an alternate payee under a qualified domestic relations order (QDRO).
• Made to a participant for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the participant itemizes deductions).
• Timely made to reduce excess contributions.
• Timely made to reduce excess employee or matching employer contributions.
• Timely made to reduce excess elective deferrals.
• Made because of an IRS levy on the plan., or
• Made on account of certain disasters for which IRS relief has been granted.

You can read more about early withdrawals in the IRS 401(k) Resource Guide.

401(k) Loans: Most 401(k) plans permit employees to borrow from their own retirement account. Typically, an individual can borrow up to 50% of the account balance or $50,000, whichever is less. Although interest rates vary from plan to plan, most charge prime plus 1 or 2 percent. The interest you pay goes back into your 401(k) account. Before borrowing from your 401(k), there are several factors to consider:

• Some plans limit borrowing to just once every 12 months.
• Interest is paid back into your 401(k) account
• Most loans are paid back over five years
• If you fail to repay the loan, you could be hit with a 10% early withdrawal penalty plus income tax
• If you leave your job, you’ll have to repay the loan in full (normally within 60 days) or you could be assessed penalties and taxes

Roth 401(k)

The Roth 401(k) was introduced with the Economic Growth and Tax Relief Reconciliation Act of 2001. This Act provides that employers could start offering these plans on January 1, 2006. According to a recent survey, 12% of employers offer a Roth 401(k), although more are expected to implement Roth 401(k) plans in 2008. Like a Roth IRA (described below), a Roth 401(k) accepts after-tax contributions only. Investment earnings grow tax-free, and withdrawals during retirement are also not subject to taxation. Unlike a Roth IRA, however, a Roth 401(k) does not have any income limitations. If your employer offers a 401(k), you can participant regardless of how much you make.

Roth 401(k)s are subject to the same contribution limits and 50+ catch-up limits as a traditional 401(k). These contribution limitations apply across all of your 401(k) plans. If you contribute to multiple 401(k)s, whether traditional, Roth, or both, your total contributions cannot exceed $15,500 (2007 and 2008) and 50+ catch-up of $5,000 (2007 and 2008). In addition, restrictions apply to early withdrawals from Roth 401(k) plans. If a hardship distribution is made, the participant will be charged a 10% penalty and assessed taxes on the portion of the withdrawal attributed to earnings. Because participants in a Roth 401(k) have already paid tax on the contributions, no tax is paid on the contribution portion of the withdrawal.

Finally, if your employer matches your Roth 401(k) contributions, these matching funds are placed in a traditional, pre-tax 401(k). This means that you will have two 401(k) plans: a Roth 401(k) for your contributions, and a traditional 401(k) for your employer’s matching contributions.

Traditional versus Roth 401(k)

A lot has been written on which 401(k) is best, traditional or Roth. The consensus almost always favors the Roth 401(k), particularly if the tax savings from the traditional 401(k) are not invested in an IRA or a taxable account. One of the unknowns, of course, is what our tax rates will be at retirement. If your tax rate today is a lot higher than it will be in retirement, a traditional 401(k) may be best. Here is a Traditional versus Roth 401(k) calculator you can use to see what’s best for you.

It’s worth noting that participants can make contributions to both a traditional and Roth 401(k) so long as total contributions do not exceed the IRS limit. That means you can hedge your bet about future tax rates if you’d like by splitting your retirement contributions between traditional and Roth accounts (on a 50-50 or some other basis).

IRA

Individual Retirement Arrangements (IRAs) are retirement accounts that are not administered by employers. Subject to certain qualifications described below, an individual can open an IRA to enjoy tax-advantaged savings for retirement. Like 401(k) plans, IRAs come in both traditional and Roth flavors. While you may qualify to open an IRA, you may not qualify to deduct your contributions. Certain limits to deductibility come into play depending on your income and whether you have access to a retirement plan at work. Here are the details.

Traditional IRA

Qualifications: Anybody can participate in a traditional IRA who is under 70 1/2 years of age and has earned income (or whose spouse has earned income if they file joint returns).

Contribution Limits: For 2007 the limit is $4,000 (plus an additional $1,000 “catch-up” contribution for those age 50 and older). In 2008, the contribution limit will be raised to $5,000, and future increases will be indexed to inflation and adjusted in $500 increments.

Deducting Contributions: If you or your spouse is covered by a retirement plan at work, you may not be able to deduct some or even all of your IRA contributions. If you are covered by a plan at work, the following table indicates whether and to what extent you can take a deduction:

If you are not covered by a plan at work, the limits on deductibility are different, as set out in the following table:

Note that this phase out limits can change from year to year. You can find more information directly from the IRS in Publication 590.

Roth IRA

A Roth IRA is similar to a Roth 401(k). Contributions are with after-tax dollars, and distributions during retirement are free from tax. One of the most significant differences between a Roth IRA and a Roth 401(k) is that your income can disqualify you from opening a Roth IRA. According to the IRS, here are the current limits:

Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:

• $160,000 ($166,000 for 2007) for married filing jointly or qualifying widow(er),
• $10,000 for married filing separately and you lived with your spouse at any time during the year, and
• $110,000 ($114,000 for 2007) for single, head of household, or married filing separately and you did not live with your spouse at any time during the year.

As I noted at the start, the rules for 401(k) and IRA retirement accounts can be involved, and they change and are adjusted regularly. So before you make any decisions related to these accounts, you should consult with your plan administrator or other retirement account specialist. If you’re interested in further reading, check out IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out.