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Heeding the Call of Social Security Reform

The debate over retirement benefits should prompt a review of your savings strategy.

The Bush administration is thinking about your retirement. Maybe you should be, too.

It may be too soon to tell how President Bush will reform Social Security -- if at all -- butit's not too soon for you to crunch some numbers, make some decisions and plot a course on how youplan to spend -- and finance -- your retirement.

There are some great savings vehicles out there, and some even better ones to come. The old 401(k)s, IRAs and Roth IRAs are still viable options, and we'll remind you of their rules later on, but the president is pushing two new ones: Lifetime Savings Accounts and Retirement Savings Accounts, both of which are basically new and improved Roths. Either way, there will be good choices available to you.

The World of IRAs

Individual Retirement Accounts, or IRAs, come in a few different flavors these days.

The old-school IRA is a tax-deductible savings account. That means you'll get a deduction on your tax return in the year you make a contribution to the account. At age 59, you can start withdrawing the money but you'll owe income tax on the withdrawals, based on your current taxbracket. The logic is that you'll be retired and in a lower tax bracket, so the income tax hit will be less.

As long as you are not covered by a retirement plan at work, for 2005 you can contribute upto $4,000 to an IRA account. You have to make that much money this year, though. If you only earn$3,500, that's all you can contribute. For 2004, your maximum contribution was $3,000, or $3,500if you're 50 and over.

If you are covered by a retirement plan at work, there are some contribution limitations.

For 2005, as a single person you can contribute to an IRA and still be covered by a plan atwork as long as your adjusted gross income, or AGI, doesn't exceed $50,000. Your contribution gets "phased out," or decreased on a sliding scale, as your AGIapproaches $60,000. At $60,000 you can no longer contribute. For 2004, the AGI phaseout covers incomebetween $45,000 and $55,000.

For joint filers, the AGI phaseout is between $70,000 and $80,000. (For 2004, it was between $65,000 and $75,000.) And for those of you who are at least 50, you can make a $500 catch-up contribution, bringing your total IRA contribution to $4,500 for 2005. These catch-up contributions were created for allthe baby boomers who spent their prime working years paying for their children's college education.

If you haven't made your 2004 contribution yet, don't fret. You have until April 15, 2005, to make that contribution as long as you meet the AGI limitations noted above.

You can list that 2004 contribution on line 25 of your 2004 Form 1040, which reduces your taxbill on the spot.

If you don't have an IRA, you have until April 15, 2005, to open one for 2004 andmake a qualifying contribution.

Another kind of IRA is the Roth IRA, which was introduced back in 1998 by then-SenatorWilliam Roth and is a great savings tool. The big perk to the Roth: While you do not get a deduction for the contributions you make today -- because you are contributing after-tax income -- the account growstax-deferred and then everything -- contributions and investment earnings -- can be withdrawn tax-free once you hit age 59.

So if you think you'll be in a higher tax bracket at retirement than you are now, the Roth may be a better choice for you.

For 2005, a single person can contribute $4,000 to a Roth, up from $3,000 in 2004, assumingyour income is below $95,000. That contribution is phased out between $95,000 and $110,000. Joint filers with income under $150,000 can make the full contribution of $4,000 in2005. The AGI contribution phaseout for joint filers is between $150,000 and $160,000.

For 2004, the maximum contribution was $3,000, or $3,500 if you were 50. The AGI phaseoutlimitations have remained unchanged and will be the same in 2005 as they were in 2004.

Because of the Roth's tax-free withdrawal perk, you may want to consider converting yourtraditional IRA to the Roth.If your AGI is below $100,000, you can convert your traditional IRA to a Roth. You will owe taxon the tax-deferred contributions and earnings in the IRA in the year you convert.

But since these are some of the lowest tax rates that we're going to see for a while, it might be a good time to swallow the extra tax bill, says Richard O'Donnell, apensions expert at RIA, a Thomson business providing tax information and software to tax professionals.

And for inheritance purposes, if you don't need the money from your traditional IRA in your retirement, convert it to a Roth and pay the taxes now. That way you can leave it all to your heirstax-free.

So whether you choose the traditional IRA, the Roth or both, just keep in mind that the total contributions you make to all your IRAs in 2005 cannot exceed $4,000, says O'Donnell. The cap was $3,000 in 2004.

The 401(k) World

If your employer offers a defined contribution plan, like a 401(k), hopefully you're taking advantage of it.

To start, your contributions are pretax, so while that means you'll get hit with tax on the withdrawals in retirement, the money comes out of your paycheck before your withholding tax is calculated. That actually lowers the amount withheld and the total amount of tax owed.

So if you can, try to make the maximum contributions. If not, you should at least be contributing up to your employer's match, should there be one. If your employer will match you upto 5%, then contribute at least 5%. That's free money for you and your condo on the beach.

For 2005 you can contribute up to $14,000 in your employer's 401(k), up from $13,000 in 2004.

Again, the 50-and-over crowd is allowed catch-up contributions, bringing their total to $18,000 for 2005, up from $16,000 in 2004.

If you happen to be self-employed, consider a solo defined contribution plan, sometimes dubbedsolo 401(k).

If you have the money, as a self-employed person, you can elect to defer up to $14,000 for 2005. Then your employer (in this case, that's you) can put in an additional $28,000 and get a deduction for it. So that's $42,000 you can sock away, up from $40,000 in 2004.

If you know you're not going to have an available $42,000 to sock away, then the old SEP IRA is a great alternative. The max you can put in is $14,000 for 2005. And you get a deduction for that contribution in the year you make it.

So whatever savings vehicle you choose, be conscious of your contributions and start socking money away.

Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University.