Downside of Ample Compensation Is Constraints on 401(k) Contribution

Q: 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% of my salary, or approximately $7,000 annually. Is that all I can save tax-deferred? Or can I open new or add to existing IRAs and deduct the contributions from my federal and state income tax?

A: 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 paid more than about $85,000 a year while allowing lower-paid workers to contribute up to the maximum--$10,500 in 2000. 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. The amount that highly paid workers can contribute depends on how much lower-paid workers put into the plans.

If you have freelance income, you can set up a self-employment plan such as a Keogh or a Simplified Employee Pension as a way to deduct more retirement contributions. You can find out more about these plans by reading any good tax guide, such as the ones published by J.K. Lasser or Ernst & Young.

Otherwise, you’re left with after-tax options. Definitely consider contributing $2,000 a year to a Roth IRA, which is not deductible but offers tax-free income in retirement. (Your 401[k] money, by contrast, will be taxed at ordinary income rates when you pull it out.)

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 this approach boosts employee participation, which in turn increases the ability of higher-paid employees to contribute. It’s a win-win situation--you get to save more tax-deferred, and your lower-paid colleagues get an automatic, virtually painless start on their own retirement kitty.

Certainty in Long-Term Uncertainty

Q: I recently read an article about long-term care insurance by a man who said 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.

A: Statistically speaking, most people’s houses don’t burn down. Therefore, the money most of us spend on homeowners insurance premiums is “lost,” so it would seem that we would be better off if we simply saved the money to rebuild our homes and invested it in the stock market or some interest-bearing account.

Of course, we’d be in a pickle if our house burned down before we finished saving. That is why mortgage lenders insist we get homeowners coverage when we buy a house.

Long-term care insurance is a different animal, of course. But we still 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, however, 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. That, and the fact that the policies are relatively new, and sorting out a good policy from a bad one can be tough.

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.

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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 https://www.unitedseniorshealth.org and its phone number is (202) 479-6973.

Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at http://161.35.110.226 /moneytalk.