The Economic Recovery Tax Act of 1981, which included large personal and business income tax cuts for the next several years, provides an important way for virtually everyone who has earned income to save for retirement on a tax-free basis. Through this year, only individuals not covered by some type of pension plan could invest in Individual Retirement Accounts, or IRAs, and claim a tax deduction in the amount of their contribution. The tax act lifts that key restriction, and it also allows larger contributions, beginning in 1982. Remember that the expanded eligibility and higher limits apply to contributions made during 1982 that will be deducted on the 1982 tax returns due April 15, 1983. Even though contributions for 1981 can be made up until April 15, 1982, the old rules apply to deductions claimed on those 1981 returns.

QUESTION: Exactly what is an IRA and what are its advantages?

ANSWER: An IRA is a an agreement between yourself and a bank, thrift institution, insurance company, mutual fund or other institution under which you make contributions to a retirement plan. Up to certain limits, the contributions can be deducted from your current income for tax purposes, and no tax is due on interest or other gains received on the investment until you begin to withdraw funds from the IRA.

Q: Who is eligible to have an IRA?

A: Through 1981, anyone who has earned income and who is not covered by a tax deferred pension, profit-sharing, stock bonus, annuity or bond purchase plan of his employer, by a federal, state or local government retirement plan, or by an annuity contract bought by some tax-exempt organizations or public schools.

Beginning in 1982, anyone who has earned income can deduct contributions to an IRA regardless of whether they are covered by a pension or other type of employer-provided plan.

Q: How much can I put into an IRA each year?

A: This year, you can deduct up to $1,500 or 15 percent of your compensation for the year, whichever is less, for contributions to an IRA.

Beginning in 1982, those limits will be raised to $2,000 or 100 percent of your compensation, whichever is less.

Q: And if I have a spousal IRA?

A: In that case, you, as the earning spouse, can deduct up to $1,750 in 1981 if you make equal contributions to both IRAs and you file a joint tax return.

Beginning next year, the limit on deductions, including a spousal IRA, will be $2,250. The new law also changes the rule that encouraged equal contributions to the two IRAs. Your deduction will no longer be limited to twice the amount contibuted to the IRA that gets the smaller contribution. Instead, you can contribute $2,000 to one of the two IRAs and only $250 to the other and still take the maximum deduction.

Q: If I set up an IRA, when can I begin to take money out of it?

A: Since the tax deferral on contributions to and interest (or other returns) earned by IRAs are intended to encourage people to save for their retirement, there generally are tax penalties if funds are withdrawn before you reach age 59 1/2. There are no tax penalties for withdrawals made sooner if you die or become permanently disabled.

Q: Will I have to pay any tax if I wait until I am that old to make any withdrawals?

A: Yes. Since you are paying no tax on the income used to make the contributions or on the IRA's earnings, you will be taxed when you make withdrawals. All withdrawals will be taxed as ordinary income in the year in which they are made. If the IRA includes property, such as stocks, bonds or real estate, the profits on it will nevertheless be taxed as ordinary income rather than as capital gains.

Q: How big are the penalties if I have to make withdrawals before I am 59 1/2?

A: Generally speaking, any early withdrawal will be taxed as ordinary income in the year of the withdrawal. In addition, there is aake contributions to IRAs through payroll deductions.

Q: All these changes in the law seem to make IRAs more attractive. Are there any new restrictions as well?

A: At least one. All along, contributions to an IRA had to be in the form of cash, check or money order. But if you had the right kind of IRA, you could direct that the money be used to purchase some type of collectible, such as art works, rugs, stamps, coins or antiques -- even wine. After 1981, use of IRA assets for investment in such tangible personal property will be treated like a premature withdrawal and taxed accordingly.

Q: What if I set up an IRA and then want to change my mind and move the money from, say, a bank to a mutual fund? Can I do that?

A: Generally speaking, you can do that without any tax penalty. If you never get the money directly -- that is, if the first institution transfers the money directly to the second -- you can change from one IRA to another as often as you wish. In addition, once a year without any tax penalty, you can have funds in an IRA paid to you so long as they are reinvested in another IRA within 60 days. There are no restrictions on what you do with the money during that period.

One caution: if your money is invested in a certificate of deposit and there is an interest penalty associated with early withdrawal from that type of certificate, you would have to incur that penalty if the funds are withdrawn other than when the certificate matures.

Q: What happens if I die before making any or only some of the withdrawals from my IRA?

A: You can designate any beneficiary you choose, including simply your own estate. The recipient, even if it is your estate, is taxed as if the money were ordinary income to him. However, if your beneficiary is an individual he can avoid the tax by assuming title to the IRA instead of cashing it in. Once he takes title, the same rules apply as if he had set up the IRA himself. If your beneficiary cashes in the IRA without taking title, no 10 percent excise tax is levied. flat penalty of 10 percent of the amount withdrawn.The same taxes and penalties apply if you use any portion of the IRA as collateral for a loan.

Q: Are there any other tax penalties I might incur?

A: Yes, there are. First, if you contribute more to your IRA than you are permitted to deduct on your tax return, you must pay an excise tax equal to 6 percent of the excess if it remains in your IRA after the last date on which contributions are permitted for a particular year. If you make an excess contribution, but take it out before that date -- which is usually the date on which your tax return is due, normally April 15 of the following year unless you are granted an extension for late filing -- no excise tax is due.

Second, since IRAs are intended to fund retirement, you must begin to make withdrawals by the year in which you reach age 70 1/2. If you do not, there is a 50 percent excise tax on any excess accumulations. In addition, the withdrawals must be made in regular amounts large enough to exhaust the funds over your lifetime and that of your spouse.

Q: How do I go about setting up an IRA?

A: You should get information about the IRAs offerred by a wide range of institutions. The paper work involved is not extensive, but figuring out which IRA is best for your circumstances will require some effort. But that effort will be worth it in the long run since IRAs vary widely in terms of investment vehicles and rates of return. They also vary greatly in terms of the amount of control you can exercise over the way in which the IRA's assets are invested.

Almost all banks and thrift institutions handle IRAs, and so do most mutual funds, whether they invest in stocks, bonds or money market securities. Many brokerage firms also provide IRAs. Insurance companies sell IRAs in the form of both individual retirement annuities and endowments. (Generally, an endowment contract is an annuity that also gives you life insurance coverage, but you cannot deduct the portion of your premium that goes for insurance.)

Q: What should I look for in choosing which kind of IRA to set up and where to get it?

A: Among the things you should consider are whether there are any fees. Most banks, thrift institutions and no-load mutual funds charge minimal fees for setting up an IRA.

You should know the interest rate being paid and how it is calculated. Banks and thrifts, for instance, generally use contributions to an IRA to purchase some type of certificate of deposit at their own institution. You may have to decide whether you want your money invested in a money market certificate that matures in six months or one with a longer maturity. When it matures, you would then decide again how it should be invested, though usually the money is automatically reinvested in the same type of certificate unless you direct otherwise.

If you are considering setting up an IRA this year, you may want to wait until after Dec. 1. The Depository Institutions Deregulation Commission has directed that, as of that date, all restrictions be lifted on the interest rates that can be paid on funds in IRAs. The thrift institutions are lobbying to get that order reversed, while the banks want it to go into effect. By waiting, you may be able to get a better deal.

If you choose a mutual fund for your IRA, dividends are automatically reinvested. Brokers may also set up an IRA in which you choose which stocks or bonds to buy, with all dividends and interest payments automatically reinvested through the account.

An IRA annuity offers the prospect of retirement payments that will run from some point after you are 59 1/2 for the rest of your life. The level of those payments will depend upon your annual contributions. Keep in mind that if you have no earned income or alimony in a particular year, you can make no contribution that year.

Finally, as a result of the new tax law, you can also make extra contributions to a pension or similar plan operated by your employer and claim the same sort of deduction as for an IRA. Moreover, a few employers have set up new plans under which employes can m