IRAs

IRAs can be a powerful tool that can help you build your finances, prepare for a better retirement, and get a hefty savings at tax time. However, some people are confused on what they are, how much they can contribute, and the deadline for their contributions. I’ll answer some common questions to help you feel more comfortable using them.

Max Out Your IRA Contributions

When should you start investing in an IRA? As soon as you can, provided that you have an emergency fund in place and don’t have any high interest (>12%) debts.

How much can you contribute to your IRA? For 2011, you can contribute $5,000/year or the amount of your taxable compensation. If you’re over 50, you get an additional $1,000 added to your contribution ($6,000/year). Don’t forget that these are for individuals, so a couple younger than 50 can contribute $10,000 into IRAs ($5,000 each). If you can max out your contributions, then please do so.

With IRA contributions, there are guidelines for the deduction and contribution limits.  If you contribute to your traditional IRA by April 17th, you may be able to claim a tax deduction on your tax return for the amount contributed.  Roth IRA contributions, however are not tax deductible since the qualified distributions are tax-free.

You can contribute to your Roth IRA if your modified AGI is less than:

• $179,000 for married filing jointly or qualifying widow(er),
• $122,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, and
• $10,000 for married filing separately and you lived with your spouse at any time during the year.

For your traditional IRA, if you or your spouse is covered by a retirement plan at work, your deduction may be limited.

Don’t worry about figuring out these limitations.  TurboTax easily guides you through the necessary entries and gives you the appropriate tax deduction to maximize your tax refund.

Make it Easy to Contribute

The easiest way to stay on target for your investment goals is to go ahead and automate your IRA contributions. It can be as small as $25/week; the important part if getting you into the habit of saving up for your retirement.

You can also set aside a chunk of any bonuses or windfalls you get this year to deposit into your IRA.

Deadlines for Contributing to Your IRA

2011 is over, but you still have until April 17th to make a tax deductible contribution to your traditional IRA and reap the benefits of a bigger tax refund.

Thoughts on Your IRA

How many of you have continued to contribute your IRA? How has it been doing this year?

Retirement

On the road to retirement, there are some decisions you’ll have which can impact your taxes along the way. Your 401(k) and IRA accounts – should you choose the traditional pre-tax flavor or Roth?  The Roth plan requires post-tax contributions, but allows tax free growth and distribution, in most cases.  If the distribution is the result of a conversion or certain rollover in under 5 years after conversion and you are under 59-1/2, you may have to pay an additional 10% tax penalty.  With pre-tax plans, you contribute to the plans with your funds without any taxes deducted so the distributions are taxable.  So which one do you choose?

One approach to consider is to look at your marginal tax rate, and see how far into that bracket you are. For example, a single filer will be in the 15% bracket from $8,500 of taxable income right until $34,500. If you find that after deductions, exemptions, credits, etc, your taxable income is $38,000, it may not make sense to be in pre-tax retirement accounts for all your retirement savings. Since only the amount above $34,500 is taxed at 25%, by putting exactly $3,500 into a pretax 401(k) or IRA, you’ll reduce your taxable income so the last dollar is taxed at 15%, and none at 25%.

If your company offers a 401(k) with a company match, see if they also offer a Roth 401(k). If not, at least be sure to deposit enough to get the match, and then use a Roth IRA to top off your savings. If the Roth 401(k) is an option, you are usually able to change between this and the standard pre-tax 401(k) on a pay cycle adjustment. The process can be fine tuned a bit by using a traditional IRA and converting some of it to Roth, as needed. A bit of attention to your taxable income and your paystubs and you should be able to take advantage of the difference between these two tax rates.

On the retiring side, you can implement a similar strategy. As a single retiree, finding yourself with a mix of pre and post tax investment accounts, by choosing the pre-tax 401(k) and IRA to make withdrawals right up to the taxable income of $34,500, and Roth or other post tax money for anything above this, you can aim to live right on the edge of 15% through retirement.

With the 2011 standard deduction ($5800) and exemption ($3700) adding to $9500 right off the top, this is about all the median earner needs at retirement. If your withdrawals are a bit lower than this, consider the strategy of converting just enough IRA money to top off that 15% bracket.

It’s not as difficult as it might appear. By looking at last year’s return and adjusting slightly for this year’s numbers, you should have a good idea where 2011 will put your taxable income. Underestimate a bit, and convert just enough IRA money to Roth to hit your goal.

If in April, your return tells you went over, just recharacterize enough to get the taxable income number dead on. This strategy for the just-retired person will help bring that IRA balance down over time to avoid some potentially large RMDs (Required Minimum Distributions) after reaching 70-1/2.  Please note: once you make contributions to a designated Roth account, you cannot later change to a pre-tax account.

Note – the rates I discussed are for the single filer. Take a peek at the page I linked above for the tax table for other filing status, the idea works the same with the numbers adjusted for status.

Year End Tax Tip

Why It Looks Attractive

In a time of stock market volatility, you might have seen your retirement investment returns diminish – and even go negative – it might be tempting to put that money to better use by paying off debt and getting rid of the interest payments. On top of that, there is fact that when you borrow from your retirement plan, you are borrowing from yourself. So, you pay off your credit card debt, but you still need to repay your 401(k) loan. You make payments plus interest back into your account, so you are paying yourself the interest, rather than giving it to the credit card companies.

This seems like a great idea, especially since, if it is a loan from your retirement account, you won’t be charged the 10% penalty (this is on top of your tax rate) for withdrawing before reaching the age of 59-1/2, and you won’t have to report the money as income.

Why You Shouldn’t Do It

Of course, there are downsides to using retirement account money to pay off your credit card debt. First of all, if you withdraw the money outright, without using a loan, you will have to pay a penalty of 10% of the amount, if you aren’t 59-1/2. Plus, the withdrawal amount will be added to your income, and you will have to pay income tax on it.

Even if you go the loan route instead, there are definite downsides to using retirement money to pay off credit card debt. You will have to pay a loan fee and you will have missed opportunities. Without that money sitting in your retirement account, working for you, you won’t have as much later. Yes, you are putting the money back as you repay your loan, but for a time, the capital was missing from your account, and you missed out on compound interest. That will result in a smaller nest egg over time.

You also can’t discount the problems that can come with a retirement account loan if you are laid off. If you lose your job while you have a loan outstanding, most plans require that you repay the remainder of the balance within 60 days. If you default on your 401(k) loan, you won’t see a ding on your credit report, but your loan will be reported as a distribution, and you will then be subject to penalties and taxes.

In many cases, taking money out of your retirement account has the potential to cost a great deal. Consider the viability of putting together a debt reduction plan before you withdraw money from your retirement account. If you do decide to take the money from your account, make sure you repay it as quickly as you can, and try to avoid penalties and taxes.

Contributions to Your 401(k)

The 401(k) plan contributions you elect to make come directly out of your salary. Since the contributions are made with pre-tax dollars, your employer does not include these amounts in your taxable income for the year. At the end of the year, when you receive your W-2 form that shows your earnings, you will notice that your wages subject to federal income tax are lower because of your 401(k) plan contributions. Since the wages are not counted in your taxable income to begin with, you do not take a deduction when you file your return. However, when you prepare your tax return, it’s possible to calculate how much income tax your 401(k) contributions saved you. For example, if you contribute $8,100 to your 401(k) during the year and that amount would be taxed in the 33 percent bracket if included in taxable income, then your tax savings is $2,673.

Increase in Your Take-Home Pay

Your 401(k) plan contributions also reduce the amount of your income tax withholding. Each time you get paid, your employer withholds money for your federal income taxes based on your expected taxable income. However, if you make 401(k) plan contributions, the amount of money subject to withholding will decrease since your taxable income is less than your actual salary. The result is more money in your take-home pay each pay period.

The Savers Tax Credit

In addition to the tax savings available for your contributions to a 401(k), the IRS also offers the Savers Credit if your Adjusted Gross Income (AGI) doesn’t exceed certain maximums. This credit offers a dollar-for-dollar reduction of your federal income tax bill. In 2010, single taxpayers whose AGI doesn’t exceed $27,750 can receive a credit up to $1,000 and married taxpayers with an AGI of $55,500 or less can receive up to $2,000. If your AGI doesn’t exceed these thresholds, you are at least 18 years of age and are not a dependent to another taxpayer, then you need to prepare IRS Form 8880 with your tax return to claim the tax credit.

Misconceptions About 401(k) Contributions

The contributions that you make to a 401(k) plan only reduce your income taxes, not your Social Security and Medicare taxes. These two taxes only apply to your earned income, but you do not get to claim any deductions before these taxes are assessed. For example, if your gross wages for the month are $2,500 and you contribute $400 to your 401(k) plan from it, there is withholding on the full $2,500 for Social Security and Medicare even though for federal income tax purposes, there is withholding on $2,100.

Length of Retirement

The first thing you’ll need to consider is how long you expect to rely on retirement income. Time plays one of the largest roles in determining the size of your nest egg. Somebody working until they are 70 needs far less in the bank than somebody planning to retire early at age 60. Not only that, but early retirees may not have the benefit of receiving Social Security or Medicare for a few years which can significantly increase the amount of money needed.

So, take a look at what you plan on doing. Things may change, but you have to start with some sort of expectations. If you’re assuming you’ll retire at age 65 and plan on living to 85 that will at least give you a starting point. Now you know that at the very least your nest egg should cover about twenty years of income.

The Kind of Retirement

What you actually do in retirement will ultimately dictate how much money you need. If you will retire debt-free, no mortgage, and don’t plan on doing any traveling or buying a new home or anything, your retirement expenses may be very low. On the other hand, if your retirement vision consists of buying a new condo on the beach in Florida and traveling to Europe every summer, well, that’s another story.

You need to sit down and actually think about what you want to do in retirement so you can create a better picture of what your income needs will be. Obviously, the younger you are, the more these dreams and costs can change, but you can still create a ballpark figure by looking at what things cost now and adjusting for inflation. A good inflation rule of thumb is an average of 3 percent per year. Another way to think about it is the cost of something doubling every 25 years.  So, if your projected annual income in retirement would be about $30,000 in today’s dollars, know that in 25 years that means it will probably cost you roughly that.

Putting it All Together

After you’ve determined how much your annual retirement will cost and figured out roughly how many years you’ll need to rely on that money it’s time to create your magic number. Using the information above, let’s say I’m 30 years old today, plan on retiring at age 65, and expect my retirement income to be about $30,000 a year based on today’s dollars. Adjusted for inflation, that means my retirement expenses when I retire will likely be about $80,000. Then if I plan that money has to last another 20 years in retirement, I end up with a figure of $1.6 million.

Don’t be shocked at the number just yet. It may sound like a lot, but let’s look at how you can get there. In the same example, that leaves me 35 years to save up to this goal. So, utilizing my company 401(k) or IRA I can start putting money aside and let it grow. Remember, there are tax breaks here as well that will ease the pain. It won’t actually require putting aside the entire $1.6 million since we have time and compound interest on our side.

Assuming I already have $25,000 tucked away for retirement, I could reach my nest egg number by saving $12,000 per year and earning a somewhat conservative 6 percent average annually. Depending on your situation and how much you already have saved or need to save that may still seem like a lot, but remember that we’re basing it off of needing to fund our entire retirement ourselves. Whether you like the direction Social Security is headed or not, chances are you’re going to receive some retirement income there as well, and that will cut into how much of your personal money you need to use. But when planning, I feel it’s always best to plan for the worst and assume it won’t be there at all and if it is, that’s just a bonus.

Get Started Today

If this example has done anything, hopefully it illustrates the importance of saving for retirement. I know young people feel there’s no money to be saved and there’s plenty of time to catch up, but you really need to get started as soon as possible. Maybe you can’t put away enough each year right now to meet your goals, and that’s okay. As long as you’re saving something you’re on the right track. Besides, what seems like a lot of money today might feel like a drop in the bucket in 20 years and you may be able to comfortably save double or triple what you need to each year. So stop kicking the tires on your retirement plan and start putting some money away. A little bit goes a long way over time.

I’d like to see an article about the tax and long-term financial implications of using 401k loans or early withdrawals to pay off debts (credit cards, student loans, mortgage, etc.). Does it make sense to be paying a higher interest rate on debt than I’m making in my retirement investments?

Deciding to raid one’s retirement plan for debt repayment is not a decision to be taken lightly. I’m glad you took the time to ask for help before taking money from your future.

A 401(k) plan is a retirement plan and the government gives us some pretty big incentives to use it exclusively as one. Consequently, my bias is to avoid taking money from a 401(k) plan at all costs. Of the examples you mention, only the existence of significant high-interest credit cards would cause me to consider making an exception. (Student loans and home mortgages are “good debt” and are typically at a low cost. The negatives, discussed below, of pulling money out of your 401(k) greatly exceed the benefits of more aggressively reducing relatively low-cost “good debt.”)

On the other hand, credit card debt can be extremely expensive. For example, if you’re paying 20% or more APY on a sizable credit card balance, it might take you a very long time to pay back your debt. As such, if you could borrow from your 401(k) plan and pay off all (or nearly all) of your credit card debt, I’d consider it. Yet even in such a situation, it’s still not a no-brainer to do so to borrow from your 401(k) plan. Here’s why:

A 401(k) loan is risky. Should you terminate employment for any reason (e.g., lay-off, spouse gets a job in a different city, you get really irritated at your boss one day, etc.) your loan is typically due, in full, within 60 days. When you can’t pay it back (and you won’t be able to – if you could, you would have paid it back already), the entire outstanding loan is considered a distribution. As such, you’ll be subject to income taxes, plus a 10% early distribution penalty if you’re under 59 ½. This potentially large sum will be due no later than the following April 15. Will you have the money available? Unlikely, making matters even worse.

An outright distribution from a 401(k) plan is no better. After all, you permanently reduce the amount available to you at retirement.

Furthermore, keep in mind your retirement plan money is typically unavailable to debt collectors, even in bankruptcy. While I believe people should pay what they owe, one needs to be wise to all the angles.

Taking money from your 401(k) plan should be a last resort and, in my mind, done only a very specific situation: as a loan to immediately and aggressively attack high-interest credit card debt by a person with a good deal of job security who is willing to make the significant commitment necessary to ensure the debt does not recur once more credit is available. Otherwise, steer clear and pay off your debt the old fashioned way – by spending less than you earn and using the difference to pay down debt.

What do you think? Have you taken a 401(k) loan or distribution? Glad you did or still paying for it?

What’s an IRA?

An IRA is an Individual Retirement Account. A regular IRA (contrasted with a Roth IRA, below), allows you to save money on a tax-deferred basis. Consequently, your account grows without an annual tax on its growth and income. Only upon distribution, ideally in retirement, do you pay tax on your regular IRA. Depending on your income, marital status, and ability to contribute to a workplace retirement plan, you might also be eligible to deduct your IRA contribution. (Here are the 2010 and 2011 IRA tax deduction rules.)

What is a Roth IRA?

A Roth IRA is an individual retirement account which creates the opportunity to save on a tax-free basis. While no Roth IRA contribution is ever tax-deductible, the growth of a Roth IRA, subject to fairly minimal requirements, is never taxed – not even during retirement when you might begin your money out. Unfortunately, not everyone can contribute to a Roth IRA, as there are certain maximum income limits (Here are the 2010 and 2011 Roth IRA contribution limits.)

Why Contribute to an IRA?

The tax benefits alone provide an enormous incentive to save for retirement by using a regular or Roth IRA. In addition, because the money is not easily available without income tax implications (and possible penalties), you are less likely to spend the IRA money than you would if the money were in your checking account. Numerous investment options – from mutual funds (including low-cost index funds) to stocks, bonds and CDs – are available via an IRA. As of 2010, you can even reverse a Roth IRA conversion.

Maximum IRA Contributions Limits

In 2010 and 2011, the maximum amount anyone can contribute to their IRA(s) is $5,000. For people who will be 50 or older by the end of the calendar year in question, an additional $1,000 “catch-up” contribution is permitted.

Earned Income Requirement

In order to contribute to either type of IRA, you must have earned income. For this purpose, earned income is defined as money earned via employment or self-employment. The only exception to the requirement you have earned income is if your spouse has sufficient earned income instead. If, for example, you do not work for pay but your spouse makes $30,000, both of you can make the maximum $5,000 contribution to your respective IRAs, since $30,000 exceeds the $10,000 ($5,000 x 2 IRAs –one for each spouse) earned income requirement.

Mixing and Matching Permitted

If you are otherwise eligible for both accounts, you may contribute to both a regular and a Roth IRA. However, the total annual limit of $5,000 ($6,000 if 50 or older), is a combined limit. Therefore, if a 45 year old contributes $3,000 to a Roth IRA, the most he may contribute to a regular IRA is $2,000.

When Can You Contribute to an IRA?

The deadline for an IRA contribution is the tax filing deadline for the year in question. Therefore, you can contribute for your 2010 IRA until April 15, 2011. Note that if you extend your tax return, you do not get an extension of time to make your IRA contribution.

Still, you can contribute to an IRA at anytime. Right now — in January 2011 —you can contribute to both a 2010 and a 2011 IRA. In fact, you can contribute to your 2011 IRA at any time from January 1, 2011 to April 16, 2012 (you get an extra day because April 15, 2012 is a Sunday).

What if You Want to Make a Deductible IRA Contribution But Don’t Have the Money?

Here’s one “trick” to consider. If your IRA deduction would be deductible but you don’t have the money, you can file your tax return indicating your intention to make the contribution by the deadline of the return. (Simply take the deduction as though you have already made the contribution). For example, you can file in February indicating a $2,500 IRA contribution. Let’s say your refund (due, in part, to this tax deduction) will be $2,500 and you receive it in March. As long as you move the money to the IRA before April 15, you’re in business—you’ve found a way to save for retirement without laying out the cash to do so. Want to report your IRA in TurboTax? It’s easy.

Taxes on Your Retirement Saving . . . While You’re Saving

When you save money in a workplace retirement plan such as a 401(k) or 403(b), you receive a tax deduction for your contribution.  Consequently, by putting money away for your future in a 401(k), you also save tax dollars today.  A regular IRA might work the same way, but it also might not. Depending on whether you have a workplace retirement plan available and your modified adjusted gross income (also known as “MAGI” which is IRS-speak for your income, more or less), your regular IRA contribution might be deductible. Learn more about the 2010 rules.

The rules for a Roth IRA are much simple— no tax deduction is permitted for any contribution.

Taxes on Your Retirement Saving . . . While You’re Working

You’ll of course hope your retirement plan money grows during the many years between when you save it and when you take it out to enjoy during your golden years.  As the last few years have unfortunately demonstrated, there’s no certainty such growth will happen. Nonetheless, over the very long term, intelligent investors ought to see significant growth over the decades.

How do taxes affect such growth? Thanks to a concept known as tax-deferral, none of your retirement plan money is taxed while it grows. Said another way, you’ll pay no tax on the money your 401(k) or regular IRA earns during your working career.  Furthermore, there’s no limit to how much it earns; you’ll still pay no tax on the growth.  However, should you take out even a single dollar from your plan prior to retirement, you’ll owe income tax. You might even owe a penalty tax on such an early distribution.

Keep in mind you can get some of your money out of your Roth IRA without paying income tax.  However, because of the long-term upside of Roth IRAs discussed in the next section, you’ll want to avoid doing so. (Retirement plans are for saving for retirement—the government gives you pretty big incentives to use them that way. Take advantage.)

Taxes on Your Retirement Saving . . . While You’re Retiring

I’ve heard spending one’s retirement plan funds is much more enjoyable than putting money in them.  Makes sense; after all, it’s why you’ve saved all along. If there’s a downside to the “harvesting” on your retirement plans, it’s that during retirement is when you begin to start paying for those tax breaks you received earlier.  Still, there are a few very important distinctions between how the various retirement plan distributions are taxed.

Distributions from regular IRAs and 401(k)s are taxed as ordinary income. In English, this means you’ll pay normal federal income tax (state income tax too, depending on the rules for the state in which you live), based on the amount you take out of your accounts.  Once you reach age 59 ½, you can take out as much as you want without any early distribution penalty. However, you do not need to start distributing money from your regular IRA and 401(k) plan at that time. In fact, not until after you reach age 70 ½ must you begin to take from those accounts From that point forward, you must take your required minimum distribution from your qualified retirement plans or face a significant penalty.

One retirement plan really shows its dramatic upside during retirement. Recall how a saving contribution to a Roth IRA provides no upfront tax deduction.  In retirement, however, distributions from Roth IRAs are not subject to federal income tax.  Consequently, the potentially enormous growth over the many years between saving and retirement is never taxed.  Furthermore, Roth IRAs are not subject to required minimum distributions, so you can leave your money in the plan until you need it.

Who says you can’t get something for nothing?  Now, let’s just hope the rules don’t change between now and when you retire.

Get more tax tips about retirement.

If you have a 401(k) available to you it’s still one of the best and easiest ways to put money away for retirement. It’s easy because it’s done at the payroll level, meaning you don’t have to worry about making deposits or calculating tax deductions at the end of the year. It’s beneficial because it significantly reduces your current taxable income and grows tax-deferred. If you think getting a tax refund is great, consider this. At the 25% tax rate, every $1,000 you put away for retirement, you will pay about $250 less in federal taxes. It’s still your money, but instead of directing it into your bank account you’re just tucking it away in an account earmarked for retirement but paying fewer taxes in the process.

More Than the Stock Market

The biggest objection I hear from people is that they don’t want to put money into their 401(k) because they don’t trust the stock market. To be honest, that’s a pretty lame excuse. That’s because virtually every 401(k) out there gives you a variety of investment choices, some of which have nothing to do with stocks. From money markets to bonds, you’ll almost always have an option to invest your money somewhere that doesn’t involve stocks if you choose to do so.

So, don’t use the recent stock market volatility as an excuse to not save for retirement. You can probably still put money away into a 100% guaranteed fund if you want. Dust off your 401(k) investment options brochure and look at what’s available to you if you have some reservations about putting money into your 401(k).

Don’t be Afraid of Withdrawal Restrictions

After complaining about the stock market the next thing I usually hear is something to do with how the money is tied up. It’s true that the money isn’t going to be as easy to get your hands on as the money you have in a savings account, but it’s not supposed to be easy. If people could tap into their retirement funds with an ATM card, nobody would ever be able to retire.

That being said, the restrictions aren’t all that bad and your money isn’t locked up forever. Money can generally be withdrawn from a 401(k) on six different occasions:

• Termination of employment
• Disability
• Reaching age 59 ½ (or 55 in some cases)
• Retirement
• Hardship
• Death

Usually, when you find yourself in a position that forces you to look towards your retirement plan for money, it’s one of these reasons. Sure, you might be bummed to learn that you can’t dip into it whenever you want to buy a new car or take a long vacation, but that’s what your other savings accounts are for.

Finally, there’s often the ability to take a 401(k) loan. More than 65 percent of all plans have a loan provision, so you have one more way to access your money if you really need it. While you still don’t want to tap into retirement savings if you don’t have to, a loan is usually a better option than a straight distribution because you aren’t assessed a penalty (as long as it’s paid back) and you actually put money back into the account to repay the loan.

Taking Advantage of Your 401(k) in 2011

As the new year approaches, you should consider how to take advantage of your company’s 401(k) in 2011 if you have one. If they offer a match, it’s a no-brainer and you should contribute enough to at least get the match. That’s free money and in most cases it’s like getting an instant 50 or 100 percent return on your money. Even if they don’t have an employer match it’s still a good idea to save. You’ll only help build your nest egg while receiving some tax breaks in the process. For most people, the contribution limit should be $16,500 with a $5,500 catch-up provision for those over 50. This is a generous limit considering the annual IRA contribution is just $5,000.

Check Your Retirement Plan Contributions

One of the first places to turn to is your retirement plan. If you’re like the millions of other Americans who put money away for retirement in a 401(k) or Traditional IRA, you have a lot of control over your taxable income. Since these are pre-tax accounts the money you contribute each year directly lowers your taxable income.

Many companies are beginning to bring back raises and bonuses late this year as the economy slowly begins to improve. This means more money for you, but it is also a perfect opportunity to jumpstart your retirement plan and take an extra bite out of this year’s taxes. Instead of pocketing any extra income you might want to consider increasing your retirement plan contributions. This is a win-win because not only do you help your portfolio grow even faster, but you’re cutting back on taxable income.

The easiest way to do this is to base your contribution rate on a percentage. Whether you contribute to a 401(k) with each paycheck or make monthly deposits into an IRA, by basing your contribution on a percentage of income instead of a flat dollar amount you’ll be sure to automatically save more if you make more.  This way you don’t even have to think about it. If you’re contributing 10% of your paycheck and you finally get a 3% raise, you’ll automatically put 10% of that 3% into your retirement plan as well. Unless you’re already extremely wealthy, you can never save too much for retirement.

Check Your Tax Withholding

Once your retirement plan contributions are in line you should probably take a look at your income tax withholding. This is another area people often overlook yet it’s an incredibly easy way to put more money in your pocket with every paycheck. By optimizing your withholding you can make sure you’re having enough withheld so that you don’t owe the IRS any money at the end of the year while making sure you aren’t withholding so much the government is getting an interest-free loan and holding your money hostage for most of the year.

For most people, tax withholding can be set by simply filing a Form W-4 with your employer. Perhaps you remember filling one of these out when you first started your job. Well, you can fill a new one out at any time, and if you’ve had changes in your life such as getting married, having a child, or anything like that, it’s a good reason to go over your withholding again.

The instructions on the form will walk you through how to estimate your exemptions, but the bottom line is the closer your exemptions are to zero, the more tax is withheld. That’s good if you want a big refund in the spring, but you can do a lot better with your money if you take control of it. If you can carefully calculate your exemptions so that enough, but less tax is withheld, you will be getting more money with each paycheck. From there, you can use that money now to pay down high-interest debt, add it to your retirement account, or simply tuck it away in savings and earn a little interest. Sure, you can do this with a single refund each year as well, but oftentimes that money doesn’t always get used as intended when it comes in as one lump sum like that.

So, while taxes may be the last thing on your mind this summer, it isn’t too early to start planning ahead. By maximizing your retirement fund contributions and streamlining your tax withholding you can be ahead of the game come April.

Jeremy is a chartered retirement planning counselor and writes about personal finance at Generation X Finance and About.com.

Shouldn’t you be working to be financially fit as well? Or, if you resolved to do so, what are you waiting for?

Here are 13 things you can do in 20 minutes to get financially fit in 2010:

1. Open Up A High-Yield Online Savings Account. Brick and mortar banks pay almost nothing these days. With most online savings accounts you can actually see your money growing and earning interest. This added incentive helps keep you going on your path to savings.

2. Re-Allocate Your Retirement Accounts. Check up on your IRAs and 401(k)s and any other accounts you may have to make sure you are sticking to an allocation plan. Many companies will let you set up an email alert when your accounts exceed a specified percentage and remind you to re-allocate your retirement plan. This helps you you retire well.

3. Up Your 401(k) Contributions to the Company Match. The company match is free money for your retirement. Really. Think your salary isn’t enough? Add the company match to it, it’ll look better. And your contributions are pre-tax which means if you are taxed at say, 25%, a $100 contribution really only costs you $75 in your paycheck.

4. Set Up an Automatic Savings Plan. Create a savings goal. Now divide that number by 12 months. Set up your online high-yield savings account (see item #1) to withdraw that amount every month. Voila! Automatic savings. Too often we say we are going to save but by the end of the month the money is spent. Make it automatic to make sure your savings happen. Don’t even give yourself a chance to get your hands on that pre-set amount, send it straight to savings.

5. Call Your Credit Card Company to Lower Your Interest Rate. How is your account? Have you been paying on time? Are you carrying a balance? If so, give your credit card company a call and ask to have your interest rate lowered. Most times they will oblige, especially if you tell them you have an offer for a better rate with another card. This could easily save you hundreds, if not thousands, on your credit card balance as well as help you pay it off sooner.

6. Contribute to An IRA. Try to contribute the maximum that you can. If done before April 15th you can still contribute for 2009. A Traditional IRA means you get tax breaks now. A Roth IRA gives you tax breaks when you retire. TAX BREAKS!

7. Donate Old Books and Clothes. Man, do our closets pile up with stuff we don’t use anymore. You too? Head to the local library and donate your old books. Ask for a receipt so the books can later be written off at tax time. Take your clothes to the Salvation Army or another charity. Get a receipt there too – donations are deductible.

8. Set Up A Bill/Pay Calendar. Late bill payments not only cost you cash but they can beat up your credit score too. Use a free application like Google Calendar to set up bill due date reminders for all of your bills. This can help you stay on top of your bills and can remind you if a bill got lost in the mail. Or, free budgeting software like Mint.com can send bill reminders for you, while also helping you easily set up budget, with alerts for when you overspend on clothes, food, or wherever you want to save money.

9. Use Tax Software (like TurboTax) for Your Taxes. When I started filing taxes I used to do them myself (ok, computers weren’t used as much either but that’s another issue). It would take my quite a while making sure I had every form and reading through all of the instructions then I started using tax software. Like butter! It was so much easier and quicker than doing my taxes on my own. Plus, you can save almost $200 by choosing tax software over an accountant.

10. Adjust Your W-4. Do you get a big tax refund every year? You know that’s a tax-free loan to the government right? And you could have that money in your paychecks instead? Adjust your W-4 withholding so your tax refund is less and you get more money in your paychecks now! Know what? You can put the difference in your online savings account (Item #1) as part of an automatic savings plan (Item #4).

11. Get Your Free Credit Report. You are allowed to get one copy of your credit report for free from each reporting agency once a year (three agencies). Mark your calendar in four month intervals and check one report each time to make sure all of the information on it is accurate. Mistakes on your credit report can cost you big time on your credit score, which can affect everything from loan rates to insurance costs to getting a job.

12. Collect Your Loose Change In A Jar. Toss your daily pocket change in a jar. When it fills up cash it in (look for a free service). You may find you saved up over $100 with very little work!

13. Make a List Before Food Shopping. Ever go food shopping with an idea for what you need then come home with $300 of groceries and still forgot stuff? I have. Write a list and keep to it. It will keep you focused on buying what you need and keep you from getting the extra. It also helps to cut down trips to the grocery store when you forget something and start the whole process of getting what you don’t need all over again.

There you have it – 13 things you can do in 20 minutes to get you financially fit in 2010.

What else can you think of?

NOTE: If you make a contribution in 2010 before the April 15th deadline, be sure to tell your broker that you want the contribution to be for the 2009 tax year. By default, they will put it towards 2010 unless you tell them otherwise.

Roth IRA vs Traditional IRA

When it comes to IRAs, there are two major flavors – the Roth IRA and the Traditional IRA. With a Roth IRA, your contributions are not tax deductible but the account balance grows tax free. When you begin withdrawing money in retirement, you are not taxed on the disbursements. With a Traditional IRA, your contributions are tax deductible but you are taxed when you begin withdrawing money in retirement. You either pay the tax today, with a Roth, or you pay a tax in retirement, with a Traditional IRA.

The general idea is that a Roth IRA is valuable if you believe your income tax rate in retirement will be higher than your current rate. If you believe the reverse is true, then you would prefer a Traditional IRA because you get tax benefits immediately. Another school of thought argues that since it’s impossible to determine where the tax brackets will shift, it’s most important to diversify your tax profile. Finally, given the contribution limits on Roth IRAs, it might make more sense to take advantage of it today because you might not be able to tomorrow.

IRA Contribution Limits

IRA contribution limits are the same for Traditional and Roth IRAs. For 2009, you can contribute up to $5,000 total. If you are age 50 and above, you can contribute a maximum of $6,000. This amount is shared between the two types of accounts, so if you want to contribute to both then the sum can’t be greater than your limit.

Roth IRAs have an additional income restriction. If you are single filer, you can contribute the maximum as long as your adjusted gross income is under $105,000. If you earn between $105,000 and $120,000, your contribution maximum will be adjusted based on how much above the lower limit you earn. If you earn over $120,000, then you cannot contribute to a Roth IRA.

For example, if you have an AGI of $110,000, or 33.3% into the phaseout, then you can only contribute 66.7% of the $5,000 limit – or $3,340. (it is always rounded up to the next higher $10 increment, or $200 if the amount is less than $200)

For married filing jointly, the two limits are $159,000 and $169,000.

2010 Roth IRA Conversion Loophole

Starting next year, anyone will be able to convert a Traditional IRA to a Roth IRA. Today, that conversion is only permitted for individuals earning less than $100,000. This is a big deal for people who can’t contribute to a Roth IRA because of the income restriction. If you are one of those individuals, read up on the Roth IRA conversion rules to be prepared.

Jim writes about money at his personal finance blog Bargaineering.com.