Q&A: Avoiding estate taxes

Dear Liz: You recently answered a question about what a wealthy couple could do to reduce future estate taxes, and you mentioned the annual exclusion. They also could pay education and medical expenses for anyone, and there’s no annual limit.

Answer: Absolutely — and the couple’s estate planning attorney almost certainly would have informed them of this option.

The original letter came from one of the couple’s children, asking what their parents could do to reduce future estate taxes, in addition to the irrevocable trust that already had been set up. The reader lamented that the estate was bigger than the current exemption limits (now $10.98 million for a married couple) and so could incur estate taxes.

My answer was that the couple’s attorney would have told them of other options. One of those options is to use the annual exclusion of $14,000 per recipient to gift tens if not hundreds of thousands of dollars out of their estate. If the couple chooses not to use available options, and instead lets the estate incur the taxes, there’s not much the heirs can do about it.

Q&A: Paying an advisor vs. doing it yourself

Dear Liz: I started with a fee-only advisor 10 years ago. She moved to another company a few years after and I followed. She’s really done well for me. My question is, now that I’m getting ready to retire, should I manage my own accounts to avoid incurring commissions or fees? I don’t anticipate making any major changes to my portfolio.

Answer: If your advisor is truly fee-only, then you aren’t paying commissions on your investments. You’re paying fees to her plus fees for the various investments you own.

You can’t avoid fees. While you’re smart to want to avoid paying too much, you also need to consider the value you’re getting. Is your advisor a comprehensive financial planner who can answer your questions on most aspects of your finances, from budgeting to estate planning? Has she helped you stick to your investment plan in good times and bad? Can she serve as a watchdog as you age, monitoring you and your accounts for signs you’re at risk for fraud or bad decisions?

If you’re not getting your money’s worth, then you have two options: looking for a cheaper deal or an advisor who will give you more service.

For example, if your advisor is just providing investment management and you’re paying more than about 1% of your portfolio for her services, then you might well consider doing it yourself or turning to one of the many automated investing services that charge one-quarter to one-half a percentage point. Alternatively, you could look for an advisor who can be a comprehensive planner for the same fee, or less, than you’re paying now.

Q&A: Taking a look at the confusing world of credit scores

Dear Liz: I was recently denied a credit card and told my score was 150 points lower than what my credit reports show. Why would this be? Am I being deceived by the credit reporting agencies? It was such a low number that it’s a little hard to believe since I have been approved for other cards recently.

Answer: The creditor that denied you should have told you which score it used and from which credit bureau in addition to the actual number. Lenders employ a variety of different scores, but most use some variation of the FICO formula. Credit card lenders tend to use FICO Bankcard scores, which are on a 250 to 900 scale in contrast to the usual FICO 300 to 850 scale. Your numbers will vary depending on the version and bureau that lenders use. For example, a card company may pull a FICO Bankcard 4 from TransUnion, a FICO Bankcard 2 from Experian or a FICO Bankcard 5 from Equifax, although many issuers use the latest version, which is FICO Bankcard 8.

If that isn’t confusing enough, FICOs aren’t the only scores in town. The scores you get directly from credit bureaus, for example, typically won’t be FICOs. You may have been looking at VantageScores or at a proprietary score. The free scores offered at many websites tend to be VantageScores, which are on a 300 to 850 scale but may not be the same as your FICOs.

If you want a clearer snapshot of where you stand before applying for credit, you can pay $20 at MyFico.com to see a bunch of your FICO scores from a single credit bureau or $60 to see FICOs from all three bureaus.

You may not be able to determine in advance which score from which bureau a lender uses, however. You also should understand that whether a score is good enough may depend on the lender and on the product. Many lenders require higher FICO scores for their better credit card deals, for instance. Sites that track credit card deals may give you some idea of how high your scores generally need to be to get approved, but there are no guarantees.

Your best course is to make sure all your scores are as good as they possibly can be. That means, among other things, paying your bills on time, not letting disputes turn into collections and using your credit cards lightly but regularly. You don’t need to carry a credit card balance to have good scores, and you should try to use 30% or less of your available credit limit at any given time. Finally, apply for credit sparingly, and don’t close credit accounts if you’re trying to improve your scores.

Q&A: When a new spouse brings surprise debt to the marriage

Dear Liz: I’m 58 and got married for the first time almost two years ago. I discovered my wife has several incredibly large outstanding student loans, including a parent Plus loan for her son’s education that she thought was in deferment and that has nearly doubled to well over $100,000. In addition, my wife has her own student loans, which total over $40,000 and have rates from 3% to nearly 7%. Needless to say, I was shocked and dismayed to discover this debt and wish she had shared it with me earlier.

We have looked into consolidating the loans into the U.S. Department of Education’s student debt relief program, which creates a monthly payment program based on income and forgives the remaining balance after 25 years. I’m uncomfortable with this plan. The long duration of monthly payments would be a big struggle and, after 25 years, we would have paid nearly $40,000 over the current principal even with the outstanding balance being forgiven.

I’m contemplating liquidating all my non-retirement accounts and half of our savings to pay off the larger parent PLUS loan.This would leave us with very little liquid reserve but still some substantial retirement accounts. Our combined income is around $75,000. We would then consolidate my wife’s lower-rate debt and try to take a personal loan out to pay off the higher rate loans if we can secure a lower rate. Do you have any other suggestions as to my options?

Answer: Your situation is a perfect example of why couples should review each other’s credit reports before marriage. At the very least, you could have figured out a plan to deal with the debt at least two years earlier and saved the interest that’s accrued since then.

As you probably know, your wife is stuck with this debt. The government can pursue her to her grave because there’s no statute of limitations on federal student loan debt collections. The government also can take part of her Social Security retirement or disability checks, something collectors of other kinds of debt can’t do. Even bankruptcy isn’t a viable option for most borrowers because student loan debt is extremely hard to get erased.

It’s understandable that you don’t want to be making student loan payments into your 80s, but paying the loans off much faster probably isn’t a reasonable option, given your income. So liquidating other assets to pay off the parent loan may be the best option. The wisdom of this approach, however, depends on how well you’ve saved for retirement, your job security and how much of an emergency fund would remain. If you lost your job after paying off the parent loan, you couldn’t get that money back to pay your expenses. By contrast, you could have your payment lowered under the Department of Education’s plan if you lost a source of income.

Consolidating your wife’s debt inside the federal student loan program would allow her to retain some important consumer protections that aren’t available with other debt, such as the ability to defer payments for up to three years if she faces an economic setback. If you do refinance your wife’s debt with private lenders to lower the rate, consider doing so with a private student loan rather than a personal loan if you want to retain the ability to write off the interest.

This is a complex decision with a lot of moving parts, so you’d be smart to discuss your plan with a fee-only financial planner before deciding what to do.

Q&A: Federal estate tax exemption

Dear Liz: You mentioned that the federal estate tax exemption limit this year is $5.49 million per person. Can I double that if married?

Answer: Essentially, yes. Married couples can double the amount that can be given or bequeathed to heirs tax free. If one spouse doesn’t use up his or her exemption, the surviving spouse can use the remaining amount in addition to the surviving spouse’s own exemption.

You also should know that you can leave an unlimited amount of money to a spouse who is a U.S. citizen. (The rules for non-citizen spouses are different and could fill a whole column on their own.) This is known as the unlimited marital deduction.

Q&A: What to do when a financial planner gives bad advice

Dear Liz: I personally like my fee-only financial advisor, who has been managing my portfolio (gained as inheritance) for the last six years. But she has me invested in bonds and gold only and insists that we wait until stock prices fall to get back in the stock market. We have been waiting for six years! My portfolio was not making much but now is declining with projections of interest rates increasing and the new administration’s potential financial implications. My current balance is only half of what it could’ve been had I stayed in my previous portfolio, set up by my previous advisor, of 60% stocks and 40% bonds. Is it time to change advisors again, or should I continue to trust my advisor’s advice? I’m one to five years away from retirement.

Answer: Your advisor is trying to time the market, despite ample evidence that market timing doesn’t work. You’ve missed out on a lot of growth, and your portfolio could take an outsized hit because bond prices suffer when interest rates rise. Big investments in gold are also problematic, given how volatile the prices of this commodity can be.

Increasing your stock exposure now comes with its own risks, of course, since the long-running bull market could end at any time. Still, you almost certainly will need the inflation-beating growth that only stocks can offer if you want a comfortable retirement. If your advisor isn’t willing to admit that she blew it, then you may want to start interviewing her replacement.

Q&A: Will paying off collections help credit scores?

Dear Liz: I have a question about clearing up collections on my credit reports. I used a credit repair company that did help me with most of the setbacks on my credit reports, but I still had collections that were recent and my scores were going up and down. The credit repair company left me to deal with the collections. Will it hurt my scores if I pay them off, and is there a way to get them off my report for good?

Answer: Paying off the collections shouldn’t hurt your scores, but probably won’t help them either. You can try to negotiate with the collection agency to stop reporting the collection accounts in return for payment, something known as “pay for delete” or “pay for deletion,” but debt experts say few agencies will agree to do that.

Plus paying off collections is more complicated than it may seem. Many agencies pay pennies on the dollar for collection accounts, which means virtually anything you pay them is pure profit. That means you should be able to negotiate a significant discount of 50% or more if you can pay in full.

However, not all collectors are ethical. Some pretend to own debts they actually don’t, so any payment to them is money down the drain. Other agencies will re-sell any debt you don’t pay in full to another collection agency, which means more collection calls.

Before you attempt to settle any collection account, visit DebtCollectionAnswers.com and download the free e-book written by consumer advocates Gerri Detweiler and Mary Reed.

Q&A: These heirs worry their parents aren’t doing enough to minimize estate taxes

Dear Liz: My parents, ages 75 and 76, have established an irrevocable gift trust for my five siblings and me. Wonderful! With the single trust, they have maxed out their lifetime gifting exemption. What else can they do with their other investments to minimize the inevitable estate taxes that will come with their deaths? They have lived a frugal life of caution and reserve, but before their nest egg can be distributed to their heirs, the government will extract millions of dollars.

Answer: If your parents maxed out their lifetime gift exemption, that means they contributed more than $10 million to the trust. It also probably means they employed an estate-planning attorney, since such trusts aren’t typically do-it-yourself projects. If that’s the case, the attorney probably has reviewed with them their other options for minimizing taxes.

They could, for example, give each sibling $28,000 ($14,000 from each parent) each year — and make similar gifts to each sibling’s spouse and children, if they were so inclined. This annual exemption limit is separate from the lifetime gifting exemption they’ve already used. If each of you is married with two kids, that would move $672,000 out of their combined estates each year.

Another way to move money out of their taxable estate, either now or at their deaths, is to donate to charities.

If they opt not to take further steps, you can take comfort in the fact that the top estate tax rate is 40%, which means the bulk of their estate will still reach their heirs. Also keep in mind that you’re in rare company — only about two estates out of 1,000 are large enough to trigger an estate tax return, now that exemption limits have been raised to $5.49 million a person.

Q&A: Social Security benefits for children

Dear Liz: My older brothers-in-law signed up for Social Security benefits at 62 and then suspended their benefits so that their children, who were under 18, could receive 50% of their checks. Is this process still available at age 62 for those with children who are below the age of 18?

Answer: In order for family members to receive spousal or child benefits based on the primary earner’s work record, that primary earner has to be receiving his or her own benefit.

In the past, people who had reached full retirement age — which used to be 65, is now 66 and is rising to 67 — had the option of immediately suspending their applications so their family could receive benefits while their own continued to grow. The “file and suspend” option was not available to people who applied for benefits before their full retirement age. And now it’s no longer available period, thanks to Congress.

If you do apply for your benefit early, keep in mind that your checks — and your children’s checks — will be subject to the earnings test. That reduces Social Security benefits by $1 for every $2 you earn over $16,920 in 2017. (The earnings test goes away at full retirement age.) Your benefit also will be reduced to reflect the early start.

Also, there’s a limit to how much a family can receive based on the worker’s record. The family maximum can be from 150% to 180% of the parent’s full benefit amount.

If you’re still working and your children will be younger than 18 by the time you reach full retirement age, it may make sense to wait until then to apply. To know for sure, though, you should use one of the calculators that takes child benefits into account, such as MaximizeMySocialSecurity.com.

Q&A: Advice for an investing newcomer

Dear Liz: I am not versed at all in money matters. I have no clue where to invest or even if I should invest. I have $5,000 squirreled away that I am totally comfortable investing for 12 months because I feel I would have no need for it before then. Can you make a suggestion where I should put it to make a safe return?

Answer: An FDIC-insured bank account.

Investing requires a longer time horizon and a willingness to risk losing some of your principal. If you can’t do either, you need to stick with low-risk, low-reward options.