Q&A: When is the right time to buy?

Dear Liz: My wife and I are young (25 and 22). We owe no one money and have built up an emergency fund with six months of expenses. We both contribute enough to our 401(k)s to get the maximum match, and I contribute the maximum to my company’s stock purchase plan. Currently we are saving $2,500 to $3,000 a month for a future home purchase. My question is will we be able to buy a decent house without getting a mortgage in three to four years at this rate? Is this something we should do? Or should we have a large down payment and pay the mortgage off quickly? We both have below average credit and mostly use cash for everything.

Answer: Since you two are so good at saving, you presumably can do the math required to determine how much you’ll have in three or four years. So what you’re asking is whether home prices will accelerate so fast in your area that what may seem like enough to buy a decent house now won’t actually buy one in the future.
The answer is: Nobody knows for sure.
The best approach is to keep your options open — and that means you’ll need to work on improving those credit scores. A year or two of using credit cards lightly but regularly, and paying off your balances in full each month, should help pull up your numbers. You could speed up the rehabilitation process by getting an installment loan such as a car loan or personal loan. Managing different types of credit responsibly is typically good for your scores.
If you wind up getting a mortgage, you may decide to pay it off quickly, or you may have better things to do with that money such as boosting your retirement accounts or saving for college educations.

Q&A: Taking a mortgage for the tax deduction

Dear Liz: My wife and I are both 66 and in good health. Currently we have about $1.2 million in IRAs. We’re receiving about $80,000 a year from a pension and $110,000 in salary. We have been aggressive about reducing any lingering debt. So we think we are in good shape for me to retire within the next year or so. If we decide to stay in our home rather than move, we will need to make some significant repairs and improvements. We were thinking of taking out a $200,000 mortgage to pay off our last remaining debt ($50,000 on a home equity line of credit) and fund the renovations. This would give us a better tax deduction and not incur the high taxes we would pay by making an IRA withdrawal. Our grown children have expressed no interest in the home after we die, so it probably would be put up for sale at that time. Does this seem like a reasonable approach if we choose to go that route? Anything we haven’t considered?

Answer: Considering the tax implications of financial moves is smart, but you shouldn’t make decisions solely on that basis. You especially shouldn’t take on mortgage debt just for the tax deduction. The tax benefit is limited to your bracket, so for every dollar in mortgage interest you pay you would get at best a federal tax benefit worth 39.6 cents. State income tax deductions might boost that amount, but you’d still be paying out more than you get back in tax benefits. You also would be locking yourself into debt payments at a time in life when most people prefer the flexibility of being debt-free.

If you’re comfortable having a mortgage in retirement, though, you might want to consider a reverse mortgage. Although once considered expensive loans of last resort for people who were running out of money in retirement, changes in the federal reverse mortgage program caused financial planners to reassess the no-payment loans as a potential wealth management tool. The idea is that homeowners could tap the reverse mortgage for funds, especially in bad markets, instead of depleting their retirement accounts.
Reverse mortgages are complex, though. The upfront and ongoing costs can be significant. Because you don’t make payments on the money you borrow, your debt grows over time and reduces the amount your heirs might get once the home is sold. You’d be smart to find a savvy, fee-only financial advisor to assess your situation and walk you through your options.

Q&A: Battling over mother’s estate

Dear Liz: Our mom did a wonderful job of preparing her estate, but she made a mistake in that she started giving away her real estate holdings to her two children a few months before her untimely death. She died before she had the chance to equalize these transactions. As her son and executor, I equalized the real estate after her death. My sister is now protesting this because she said “legally” what was given away before death is not part of the estate, but I say that our mom would have wanted this equalized because she was very firm in her belief that her assets be divided equally. What’s your experience?

Answer: You just provided an excellent example of why it can be problematic to have an executor who has a personal stake in how an estate is settled.

You wouldn’t be the first executor to decide that what Mom really wanted was for you to reap a larger benefit than your sibling, despite the explicit terms of a will or trust. Even if the estate documents gave you some discretion, you should have consulted an estate-planning attorney before deciding to help yourself to a bigger portion of your mother’s assets.

This is more than an ethical issue. Executors have a legal responsibility known as a fiduciary duty to the estate and all its beneficiaries. Basically, that means acting with the utmost integrity and putting the interests of the estate and beneficiaries ahead of your own.

Your sister may be able to file a lawsuit against you or ask a court to remove you as executor. You shouldn’t let it come to that. Talk to an attorney now about the best way to resolve this situation amicably.

Q&A: Social Security disability insurance and survivor benefits

Dear Liz: My first wife died six years ago at age 60. I was 52 and we had been married 27 years. My wife was on Social Security disability for 15 years before her death. My only dealing with Social Security after her death was to cancel her payments. I received no benefits of any kind. I am now remarried. Were there any Social Security benefits that I failed to request? Is there any effect on my future retirement?

Answer: You may have been eligible for a one-time payment of $255, but that’s likely all.

We’ll assume your wife was receiving Social Security Disability Insurance payments, which are disability checks paid to workers who have enough work credits in the Social Security system. SSDI is different from Supplemental Security Income, or SSI, a need-based federal program for low-income individuals who are disabled, blind or over the age of 65. Survivor benefits aren’t available under SSI, but they are under SSDI.

The rules for SSDI survivor benefits are similar to those under regular Social Security. Survivor benefits typically are available starting at age 60. Survivors who are disabled can begin receiving the benefits starting at 50, and survivors at any age can qualify if they’re caring for the deceased person’s child who is under 16. When you remarry before age 60, you can’t claim survivor benefits based on your first wife’s Social Security record unless the subsequent marriage ends in death or divorce.

Q&A: Renovations with high returns

Dear Liz: What renovation projects reap the most return when selling? Replacing windows and carpeting is what I had in mind.

Answer: Remodeling magazine’s latest Cost vs. Value report puts window replacement near the top of renovation projects that pay off, but none of the projects the survey tracked recouped more than they cost.

In 2014, a homeowner could expect to recoup about 79% of the cost of window replacements, assuming the home was sold soon after the improvement. Major kitchen remodels offered a 74% return on a mid-range project that cost about $55,000, or 64% of a high-end project that cost about $110,000. The amount you can expect to recoup usually declines over time as the improvements start to get dated or suffer wear and tear.

The survey doesn’t track projects that are typically considered more maintenance than improvement, such as replacing carpeting or painting. Those projects may, however, get a home sold faster if done just before the house is put up for sale.

Q&A: Terminating private mortgage insurance

Dear Liz: I bought my first home about a year ago. Because I had very little money for the down payment, I have to pay private mortgage insurance, which is a whopping $385 each month. My burning question about this is: How can I get rid of it? There must be a way to pay the loan quicker or pay more each month or something to make it go away.

Answer: Mortgage insurance protects the lender in case you default on your loan. Since loans with small down payments have a higher risk of default, mortgage insurance is typically required until your balance falls to 80% of the original value of your home. At that point, you can request in writing that the mortgage insurance be canceled. If you don’t make the request, the lender is still typically required to terminate PMI when your balance reaches 78% of the home’s original value.

To speed that day, you can pay down your principal, but do it the right way. Call your mortgage servicer and ask how to be sure the extra money you submit is reducing your mortgage balance. Otherwise, your extra money may just be applied to the next month’s payment, which won’t help reduce your balance much.

Q&A: Paying a deceased person’s debts

Dear Liz: When I read the letter from the woman about her mother’s debts, it brought back my situation with my brother and mom. My brother was trustee to my mother’s living will and told her she had no money. At 90, she became worried and wanted to cut back on the care she needed. My brother had the same attitude as the woman who wrote you that her mother’s property was not an asset for her to use but something to be hoarded for the heirs.

Answer: That’s not the situation the daughter described. She was asking whether she and her sister were responsible for her mother’s debts. They are not. The mother’s estate would be responsible, and her estate would include her home. If the estate’s assets aren’t sufficient to pay all the bills, however, the creditors wouldn’t be able to come after the daughters. Still, some collection agencies have been known to contact survivors, telling them they have a “moral obligation” to pay the dead person’s debts.

Q&A: Follow up on the Windfall Elimination Provision

Dear Liz: You recently addressed the issue of the Windfall Elimination Provision, which reduces Social Security benefits for people who paid into Social Security but who also get a pension from an employer that does not pay into the system. My wife taught for nearly 40 years. Neither she nor her employer contributed to Social Security. As a result she falls under the WEP. This also, however, affects her spousal benefits under my Social Security record. So, because of the WEP, any spousal benefits she would be entitled to are essentially zeroed out since she receives a pension. If she had never worked (thereby not contributing to Social Security), she would be entitled to her entire spousal benefit. That doesn’t seem reasonable to me.

Answer: What you’re referring to is a different provision, the Government Pension Offset. People who receive a pension from a federal, state or local government job that didn’t pay into Social Security can have their Social Security spousal or survivor benefit wiped out by the GPO. By contrast, the Windfall Elimination Provision typically leaves at least half of the worker’s Social Security benefit intact.

The rationale for the GPO goes like this: Spousal and survivor benefits are considered dependent’s benefits. The law has always required that these benefits be offset dollar for dollar by the amount of the person’s own retirement benefit. So if your wife had earned a $1,000 monthly Social Security benefit based on her own work record but a $500 spousal benefit based on yours, she would not receive both. Her own benefit would completely offset the spousal benefit.

Before the GPO, though, your wife could have received a $1,000 monthly pension from a job that didn’t pay into Social Security plus a spousal or survivor’s benefit from Social Security, leaving her much better off than someone who had paid into the system.

Q&A: The tax implications of downsizing

Dear Liz: My mother just turned 75 and wants to downsize from her four-bedroom house. My father passed away six years ago. She owns her home outright, and at the time of my father’s death the value of the house was estimated at $1.2 million. Right now she has enough income from retirement accounts and investments to live comfortably. She could even buy another smaller property if need be. As the executor of her estate, I’m trying to help her decide what to do with the house. She could let another family member live in it who couldn’t pay rent but could help with upkeep; she could rent it out for market value; or she could sell. We see advantages and disadvantages with all three options. What do you think?

Answer: If she hasn’t already, your mother needs to hire a good estate-planning attorney who can help her evaluate her options. Consulting a fee-only financial planner and a tax pro may be a good idea, as well.

If she sells, your mother could face a sizable capital gains tax depending on where she lives. Federal law allows a certain amount of capital gains on the sale of a primary residence — $250,000 per person — to be excluded from income, but after that, capital gains taxes apply.

The gain would be the difference between the home sale proceeds and your mother’s tax basis in the home. At least half of the home received a “step up” in basis to the then-current market value when your father died. If your mom lives in a community property state, such as California, both halves of the property would have received this step up at his death. Any increase in value since then would be subject to capital gains tax (minus, again, the $250,000 federal exclusion).

There’s another tax issue to consider. If she dies owning this house, her heirs would get a tax basis equal to the property’s value at her death. In other words, regardless of the state where she lives, none of the house’s appreciation during her lifetime would be taxable.

The tax issues alone shouldn’t dictate what your mother does. But she should be aware of them to make an informed decision about what to do next.

Q&A: Social Security survival and spousal benefits

Dear Liz: If my spouse takes spousal benefits from Social Security before his full retirement age, does that ultimately affect the survivor benefits he could receive?

Answer: As covered in previous columns, applying for spousal benefits before his full retirement age of 66 or 67 will lock him into a diminished check and preclude him from switching to his own benefit later. It does not, however, affect what he would receive as a survivor. His survivor benefit would be equal to what you were receiving at your death. To protect him (and yourself, should you be the survivor), you probably should delay starting benefits as long as possible to make sure you’re receiving the maximum benefit.