Pension Plans and Individual Retirement Accounts:
How They Work Together

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Many people take advantage of a tax break offered by the Internal Revenue Code by contributing up to $2,000 each year to an Individual Retirement Account (IRA). You pay no income tax on contributions to an IRA, or on the interest it earns, until you withdraw the money at age 59 1/2 or later.

However, most people may contribute to an IRA only if they are not working in jobs for which their employers provide a pension plan. And IRAs are generally not available to both spouses in a married couple even if only one of them participates in an employee-sponsored pension plan.

For lower income workers, there is an exception to this prohibition on combining an IRA with a pension plan. If you, or a spouse, participate in an employer-sponsored pension plan and your annual adjusted gross income is less than $25,000--$40,000 for a couple filing jointly-you can make IRA contributions and take the full tax deduction. If you earn between $25,000 and $35,000 in adjusted gross income--between $40,000 and $50,000 for a couple--the amount of your IRA tax deduction is reduced: for every $1,000 income over the limit, the $2,000 IRA tax deduction is reduced by $200.

Even if you cannot get the immediate tax deduction for IRA contributions because you participate in a pension plan and earn more than the income limit, the earnings on any contributions you have made remain tax deferred until retirement. Once you and your spouse retire or move to another job without a pension plan, you can invest in an IRA and take the full tax deduction. And you can continue to contribute to an IRA even after you begin collecting pension benefits.