Downside of good income is limit on IRA activity

Also, try to determine if you need insurance for long-term care

Dollars & Sense

January 07, 2001|By Liz Pulliam Weston | Liz Pulliam Weston,LOS ANGELES TIMES

I am contributing as much as I'm allowed to my company's 401(k) plan. As a "highly compensated employee," my contribution is limited to 6 percent of my salary, or approximately $7,000 annually. Is that all I can save tax-deferred? Or can I open new IRAs or add to existing IRAs and deduct that from my federal and state income taxes?

You can't deduct an IRA contribution if you're covered by a plan at work and your income is above certain limits. (This year, the limit for a full IRA deduction is $32,000 for singles and $52,000 for married couples filing jointly.)

You've discovered the downside of a good income. Companies often limit 401(k) contributions by employees who are paid more than about $85,000 a year while allowing lower-paid workers to contribute up to the maximum - $10,500 this year.

The reasons are complex, but it basically has to do with fairness. The rules are there so companies will encourage their lower-paid workers to participate and not funnel all the benefits of the program to higher-paid workers.

If you have free-lance income, you can set up a self-employment plan such as a Keogh or a Simplified Employee Pension as a way to deduct more contributions.

Otherwise, you're left with after-tax options. Consider contributing $2,000 a year to a Roth IRA, which is not deductible but offers tax-free income in retirement.

You might suggest to your company's managers that they consider an automatic sign-up plan, in which new employees are enrolled in the 401(k) unless they choose to opt out. Other companies have found that this approach boosts employee participation, which in turn increases the ability of higher-paid employees to contribute.

I recently read an article about long-term care insurance by a man who argued that the money spent for premiums should instead be set aside and invested in the stock market or some interest-bearing fund. That way, the money would be available for long-term care if needed but would not be "lost" as it would with insurance. His argument was that statistically speaking, most people die fairly quickly after they become unable to care for themselves. Therefore, insurance for long-term health care often was not necessary and was money down the drain. To me, that argument makes sense.

With long-term care insurance, we run into the problem of not knowing when, whether or how much we'll need it. Most people who require long-term care are old and need it for only a few years. That doesn't mean you can't get Alzheimer's in your 50s, or that you won't linger for decades if you go into a nursing home. It's that uncertainty that makes long-term care insurance a complex issue.

If you can save enough, and save it in time, then your source is correct: You don't need insurance. In fact, most financial planners don't recommend buying long-term care insurance if you're rich enough to pay for care directly; "rich enough" is typically defined as someone with more than $1 million in assets.

People with few assets also are told not to bother with long-term care insurance, because they probably would qualify for government welfare in the form of Medicaid.

It's everyone in between who faces the question of whether to buy the insurance.

If you're interested in learning more, United Seniors Health Cooperative offers "Long-Term Care Planning: A Dollar & Sense Guide" for $18.50.

Its Web site can be found at www.unitedseniorshealth.org, and its phone number is 202-479-6973.

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