Back in the mid-1980s, Michael did what many American workers did.
He took advantage of existing tax breaks to invest thousands of dollars in an individual retirement account, or IRA.
But Congress sharply curtailed the IRA tax benefits for middle- and upper-income taxpayers in 1986.
"I haven't contributed a penny since," says Michael, 39, who earns $40,000 a year working for a large company.
He stopped because the 1986 restrictions prevent him from taking a tax deduction when making an IRA investment.
"Most people have written off the value of an IRA account," says Lee Crawford, head of the money-management firm Crawford Capital Management Inc.
"They don't feel it has any advantage if they can't deduct the contribution from current income." But, says Mr. Crawford, " 'T'ain't so."
There are compelling reasons why taxpayers such as Michael should make an annual IRA contribution -- even if they are already covered by a company pension plan and can't take the deduction.
Although higher-income earners cannot deduct their IRA contributions (a maximum of $2,000 annually), their earnings on their IRA investments still grow tax-deferred. And that can make a significant difference -- as much as 20 percent to 40 percent more spendable cash by the time retirement rolls around.
An investment that compounds tax-deferred year after year grows faster than one that is taxed, as Mr. Crawford demonstrates in this example:
A 40-year-old wage earner, in the 35 percent tax bracket (federal and state combined), stashes $2,000 in her IRA every year. Invested in a mutual fund earning 12 percent annually, the IRA grows tax-deferred to $161,397 after 20 years.
Of course, the wage earner would eventually have to pay taxes when the IRA is withdrawn, after age 59 1/2 . Assuming she's still in a 35 percent tax bracket, she would be left with $118,908.
Had she chosen instead to invest the $2,000 a year in the same mutual fund, but not designated it as an IRA, she would have only $96,504 at the end of 20 years. That's a difference of $22,404.
If that investor found herself in the more likely position of being in a lower tax bracket upon retirement, she would save even more. At a 20 percent combined federal and state bracket, she would pocket $137,118, or $40,614 more than with the non-IRA account.
"There's great leverage to that tax-free buildup," says J. D. Hurley, certified public accountant and manager.
Stuart R. Josephs, a certified public accountant, says that, regrettably, many taxpayers don't invest in IRAs because they no longer qualify for the deduction. And those who do qualify often can't afford to.
Here are the basic rules of IRA investing:
You can't put more money into an IRA than you have earned in one year. However, the maximum investment allowed for most individuals is $2,000.
Individuals who are not covered by a company retirement or 401 (k) plan can deduct IRA contributions regardless of their incomes.
But individuals who qualify for a company pension can take a full IRA deduction only if they earn less than $25,000 a year. Or they lTC can take a partial deduction if they earn between $25,000 and $35,000.
The limits for married couples in which at least one spouse has a company pension are a combined income of less than $40,000 to qualify for a full deduction and between $40,000 and $50,000 for a partial deduction.
Taxpayers who make non-deductible IRA contributions must file an extra form, No. 8606.