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Retirement accounts offer tax relief

Rules for IRAs, 401(k)s, and other plans vary, so plan wisely.

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Last week, my column reviewed strategies Americans can employ to lower their income-tax bill. Today's focus is on year-end retirement issues.

Retirement planning begins the moment you take a job and continues throughout your employment. Whether you work for someone else or are self-employed, decisions on funding retirement accounts can have a substantial effect on how much money you have when you retire. Many decisions must be done carefully as they are difficult to reverse without penalty, so it's best to consult with a tax adviser before making any significant moves.

IRAs and 401(k)s

For 2008, those below age 50 may contribute up to $5,000 to an individual retirement account and those 50 and over may contribute up to $6,000. If you contributed this year to an employer-sponsored retirement plan, deductions for a traditional IRA begin to phase out if your modified adjusted gross income (AGI) is greater than $53,000 for single filers or $85,000 for those married filing jointly. If your spouse has an employer-sponsored retirement plan such as a 401(k), but you do not, deductions begin to phase out at $159,000. You must have taxable income to contribute to a traditional IRA.

Unlike a traditional IRA, contributions to a Roth IRA are not tax deductible. But withdrawals are free from federal taxes if the account has been held for at least five years and you have reached age 59-½. Maximum contributions to a Roth are the same as those for traditional IRAs, but the contribution phase-out stage begins when AGI is $101,000 for single filers and $159,000 for married couples filing jointly. Unlike a traditional plan, you can make contributions after age 70-½.

Taxpayers are allowed to contribute to both a 401(k) and an IRA in the same year, subject to income limitations. For employer-sponsored 401(k) plans, the maximum contribution is $15,500 in 2008. If age 50 or older, you can make an additional $5,000 catch-up contribution.

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