For 2002, the contribution limits have been raised for both traditional IRAs and Roth IRAs. You will be able to contribute the lesser of your earned income or $3,000 to a traditional IRA or a Roth IRA, or both, as long as the total contribution to both IRAs does not exceed the maximum allowed.

Individuals who will be age 50 or older before the end of 2002 are permitted to contribute an additional catch-up contribution of $500. The catch-up contribution can likewise be made to either the traditional or Roth IRA.

Single individuals not covered by a company retirement plan, and married couples where neither spouse is covered by a company retirement plan, can deduct their contribution to a traditional IRA, regardless of income. Otherwise, the deductibility is based upon income.

If you are able to deduct your contribution to a traditional IRA and you are also eligible to contribute to a Roth IRA, you will have to decide between the immediate gratification of a tax deduction vs. the long term benefit of the tax free Roth. (My opinion is that the Roth is better deal, but some people just can't give up that instant gratification!)

However, if you cannot deduct the contribution to a traditional IRA because you (or your spouse) are covered by a company retirement plan and your income exceeds the deductibility limit, then contributing to a Roth IRA is a no-brainer, assuming your income isn't so high that you are precluded from contributing to a Roth. The Roth IRA clearly beats a non-deductible traditional IRA. The single taxpayer phase-out range to contribute to a Roth IRA is $95,000-$110,000 of modified adjusted gross income (MAGI) . For married filing joint filers the phase-out range is $150,000-$160,000 of MAGI.

If you are covered by a company retirement plan and your modified adjusted gross income (MAGI) falls within the IRA deductibility phase-out range ($34,000-$44,000 for single taxpayers; $54,000-$64,000 for married joint filers), you can contribute the deductible amount to the traditional IRA, and contribute the remainder of the allowable contribution to the Roth IRA. For example, suppose you are single, under 50, covered by a 401(k) plan at work, and have a MAGI of $40,000. Your maximum deductible IRA contribution is $1,200. If you contribute $3,000 all to the traditional IRA, you will receive a $1,200 tax deduction and the remainder of the contribution, $1,800, will be non-deductible. The income earned by this $1,800 will be taxed when withdrawn. But if you contribute only $1,200 to the traditional IRA you will get the same $1,200 tax deduction. You can then contribute $1,800 to a Roth IRA where the income earned will be totally tax free when withdrawn after five years and after age 59½.

If a married taxpayer is not covered by a company retirement plan, but their spouse is, the phase-out range for the non covered spouse to deduct their traditional IRA contribution is $150,000-$160,000 of MAGI. Coincidentally, this is the same phase-out range for married joint filers to contribute to a Roth IRA. These phase-outs are mutually exclusive, so that you can take advantage of both phase-outs. For example, suppose you are over 50, married filing a joint return, are not covered by a company retirement plan but your spouse is, and your joint MAGI is $155,000. Because you are exactly half way through the phase-out range, you IRA deduction is limited to ½ of the $3,500 maximum, or $1,750. Your maximum Roth contribution is also $1,750. So even though your Roth contribution is limited to $1,750, and your deduction for a traditional IRA contribution is only $1,750, you can still get the benefit of both contributions by splitting the annual contribution between the two accounts.

In real life, one normally will not know their MAGI until they file their tax return. While one can wait until they know their MAGI before making their annual IRA contributions, you could be losing up to 15 months of tax deferred or tax free growth by not funding your IRAs as early in the year as possible.

The solution is to fully fund one of your IRAs, either the traditional or Roth, and then utilize the tax law provision of recharacterization to move part of the contribution to the other IRA once you determine your MAGI.

If you wish to follow this plan it is strongly suggested that you create a brand new IRA account to hold the annual contribution. That's because the recharacterization has to include applicable income, which can be a difficult computation, A separate account will somewhat simplify the math. Once you do the recharacterization, you can then merge the annual contribution into your pre-existing IRA account.

For example, on January 22, 2002 you contribute $3,000 to your year 2002 traditional IRA, You put this into a brand new account. On April 2, 2003 you determine that only $1,400 of the contribution will be deductible, so you recharacterize $1,600 (plus applicable income) into your Roth IRA. After you do the recharacterization you can then merge the remainder of the 2002 IRA contribution with your other traditional IRAs.

Careful planning with partially deductible IRAs and Roth IRAs will give you the best benefit of the combination of tax deductions and tax free growth. Keep in mind that even if your income is so high that you cannot do either a deductible IRA or a Roth IRA, the non-deductible traditional IRA is still a good deal that should not be passed up. Don't let the need to file the form 8606 stop you from taking advantage of it.