Q&A: Credit scores and card limits

Dear Liz: I have a 780 credit score but noted that one of my cards doesn’t count in the percent of credit used. I have had this card for 44 years and I could charge a couple hundred thousand dollars on a single purchase if I chose to, yet credit scoring formulas don’t figure in the “credit I have available” from Amex. Seems unfair?

Answer: As credit cards with six-figure limits are rare, what you’re describing is probably a charge card. Unlike credit cards, charge cards don’t have preset spending limits. They also don’t allow you to carry a balance from month to month, typically.

The “percent of credit used” you mention is called credit utilization, and it’s a large factor in credit scoring formulas. Credit utilization measures how much of your available credit you’re using, and the bigger the gap between your credit limits and your balances, the better.

But the credit utilization calculation can’t be made if one of the numbers — the credit limit — is missing. The only way the formulas would be able to calculate credit utilization in that case would be to assume that whatever amount you charged is equal to your credit limit, and that would be disastrous for your scores.

Q&A: Withdrawals from an inherited 401(k)

Dear Liz: A relative inherited a 401(k) as a listed beneficiary, and it was simply rolled over into an IRA in her name. Now another family member wants some of the money. The relative keeps trying to explain that if she pulls out any or all of the money, it will be taxed and reduce the amount available if she did want to share it. She is already retired and doesn’t need to use the money. She wants to keep it as part of her joint estate with her spouse, who could possibly use it later to pay off their mortgage. Wouldn’t she be foolish to pull the money out just because another family member thinks he should get some of it?

Answer: Your relative needs to talk to a tax professional.

Required minimum distribution rules prevent people from keeping money in retirement accounts indefinitely, and the rules recently changed regarding inherited retirement accounts. Your relative needs to understand the rules that apply to her, since failing to follow those rules can incur hefty penalties. Exactly how those rules apply depends on when she inherited the money and her relationship to the deceased.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 eliminated the so-called stretch IRA, which allowed non-spouse beneficiaries to minimize distributions so that inherited retirement accounts could continue to grow tax deferred for decades. Now, non-spouse beneficiaries are typically required to drain the account within 10 years of the original owner’s death. These rules apply to retirement accounts inherited after Dec. 31, 2019. Even if she inherited the money earlier, she would still need to begin distributions at some point. Failing to make these required distributions incurs a tax penalty equal to 50% of the amount that should have been withdrawn but wasn’t.

Of course, just because she has to withdraw the money and pay taxes on it does not mean she has to cave to the family member. The withdrawals are hers to spend, invest, share or save as she wishes.

Q&A: What you need to do when free health insurance for unemployed people ends Sept. 30

Dear Liz: My husband lost his job and we are on COBRA continuation coverage for our health insurance. We won’t have to pay the premiums through Sept. 30, thanks to the American Rescue Plan, which passed in March. Is there anything we can take advantage of Oct. 1 if my husband is not back to work? I understand that there’s a special enrollment period right now for Affordable Care Act coverage that ends Aug. 15. My husband’s 18 months of COBRA coverage ends in December but it’s very expensive and we’d like something cheaper.

Answer: The two of you should be allowed to switch to an Affordable Care Act policy once your free COBRA coverage ends.

COBRA allows people to extend their workplace health insurance for up to 18 months after losing their job, but as you’ve noted, the costs can be high. COBRA coverage requires paying the entire premium that was once subsidized by the employer, plus an administrative fee. ACA policies, by contrast, are typically subsidized with tax credits that make the coverage more affordable.

The American Rescue Plan requires employers to pay COBRA premiums for eligible former employees for April through September. The employers will be reimbursed through a tax credit. (The subsidy may last fewer than six months if someone’s COBRA eligibility ends before September, or if they become eligible for group coverage through their job or their spouse’s job.)

When the premium-free coverage ends, your husband would be qualified for a special enrollment period that allows him to switch to an Affordable Care Act policy.

Not only that, but anyone who is unemployed at any point during 2021 will qualify for a premium-free comprehensive policy through the ACA for the rest of the year. HealthCare.gov will have details later this month.

Q&A: Account closure and credit scores

Dear Liz: My mother is very focused on her credit score, which is consistently excellent. I found out that she recently called her bank and asked it to lower her credit limit on one of her long-held credit cards from $32,000 to $5,000. She uses the card only to charge infrequent, small amounts and always pays it off. She believes having a large credit limit counts as “potential debt” and hurts her credit profile, whereas I believe having a high credit limit on a lightly used card is very good for your credit. I guess we’ll find out who’s right next month when my mom diligently checks her credit score. In the meantime, could you weigh in?

Answer: You are correct. Credit scoring formulas like to see a big gap between the amount of credit you’re using and the credit you have available. Lowering your credit limit on a card can have a negative effect on your scores.

Before the advent of credit scoring, lenders did worry that someone with a lot of available credit would suddenly run up big balances and default. Data scientists discovered, however, that people who had been responsible enough to be granted high limits tended to remain responsible with their credit.

If your mother has several other credit cards and uses this one lightly, the effect may not be significant. If she wants to keep her scores high, however, she probably shouldn’t repeat the experiment with any other cards.

Q&A: Dad didn’t trust banks. How to handle the hoard he left behind

Dear Liz: My father was eccentric and given to conspiracy theories. He didn’t trust banks or the stock market and invested the bulk of his money in gold coins and bars. We are talking millions of dollars at current gold prices. My parents set up a living trust, so when my mother dies, I am confident the gold will be distributed equitably to myself and my siblings, without a lot of hassle in probate. But I have no idea how to convert all that gold into a more liquid investment like an IRA or money market fund. How do I do it and not be overwhelmed with fees and taxes?

Answer: Let’s hope the gold is safely stored and properly insured. It would be a shame if burglars walked away with your inheritance.

If your mother’s estate is large enough to owe estate taxes, the estate will pay those — not the heirs. (The current exemption is more than $11 million per person, so very few estates owe this tax.)

Under current law, the gold will receive a new, “stepped-up” value for tax purposes on the day your mother dies, said Jennifer Sawday, an estate planning attorney in Long Beach. You should note the price of gold on that day, using a reliable gold pricing site, and print out the information for future tax purposes, Sawday said.

Once you receive the gold, you can take it to a precious metals exchange and cash it in. If the price you get is higher than the price of gold on the day your mother died, you would have a taxable capital gain. If the price is lower, you would have a capital loss. You wouldn’t owe any taxes and could use the loss to offset capital gains elsewhere or, if you don’t have gains, as much as $3,000 of income per year until the loss is exhausted.

You can deposit the cash in a bank account, or open a brokerage account and choose your investments from there. Those investments might include a money market fund as well as stocks, bonds, mutual funds and so on.

An IRA is a type of retirement account, not an investment, and requires you to have earned income to contribute. The contribution limit is $6,000 this year, or $7,000 if you’re 50 or older, so you wouldn’t be able to put much of your inheritance into an IRA in any case.

An excellent use of some of this cash would be to hire a fee-only, fiduciary financial planner who can help guide you on how to invest the money wisely and with an eye to minimizing taxes.

Q&A: When to claim Social Security

Dear Liz: The common assumption seems to be that, in most cases, it’s a good idea to delay collecting Social Security because the longer you wait, the higher your monthly benefits will be. I will reach my full retirement age of 66 years and 2 months in July. According to the Social Security Administration website, my monthly benefit would get bumped up if I waited to start collecting until 66 years and 8 months, next February. The next bump wouldn’t be for another full year, at 67 years and 8 months. My current plan is to retire in March or April of next year. Is there any reason I shouldn’t start collecting my benefit as soon as I get to the 66 years and 2 months threshold?

Answer: It’s not clear what you were looking at, but your Social Security benefit earns delayed retirement credits every month you put off your application after your full retirement age. Those credits add up to 8% annually and increase your checks for the rest of your life.

Social Security can be complicated, and making the right claiming decision isn’t always easy, but your choice can have a huge impact on your future financial security. Please consult a fee-only, fiduciary financial planner before you retire so you can be confident you’re doing the right thing.

Q&A: This $1 house deal comes with elder care responsibility. It could get complicated

Dear Liz: My father-in-law died recently. My mother-in-law is not well enough to live alone. My husband has a brother and a sister who would like my husband and me to buy my in-laws’ big, old home for $1, take care of my mother-in-law 24/7, and make 60 years’ worth of updates and repairs to the house. I see plenty of downsides to this arrangement, but no upside. Is there a way this deal can work for us, and not just for the other siblings?

Answer: The upside is that you would own the house. Although the home may not be in great shape, it presumably is an asset with some value. Whether it has enough value to be worthwhile, and whether you want to acquire it this way, are open questions.

If you and your husband buy the home for $1, the IRS will assume that your mother-in-law gave the two of you her property, and that can be problematic. The difference between the sale price of the home and its fair market value would be treated as a gift for gift tax purposes, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Your mother-in-law probably wouldn’t owe gift taxes, but she likely would have to file a gift tax return, and the gift would use up part of her lifetime gift and estate tax exemption.

If the home is a gift, you get her tax basis, as well. If instead she bequeathed the home to you and your husband in her will, the home would get a new, stepped-up value for tax purposes. How big a deal this might be depends on a lot of factors, including which state the home is in, so you’d need to consult a tax professional for details.

On the other hand, taking title to the home before your mother-in-law dies ensures that you and your husband actually get this asset. If it’s left in a will, your mother-in-law could change her mind and leave it in full or in part to someone else. If she doesn’t have a will, the house would be divided according to state law, which probably means your husband would have to share the asset with his siblings.

There are other aspects to consider. Taking care of another person can be costly: Caregivers spend nearly 20% of their personal income on out-of-pocket costs related to helping a loved one, according to an AARP study in 2019.

Also, more than half of family caregivers adjust their work hours by taking time off, reducing their hours or quitting altogether, AARP researchers found. In addition to losing income, they can lose promotions, job security and opportunities to save for retirement.

Caregiving also is associated with higher levels of stress, worse health and increased risk of death, according to the Centers for Disease Control.

Before you take on this task, consider hiring a geriatric care manager to help you assess your mother-in-law’s needs and discuss alternatives. You can get referrals from the Aging Life Care Assn.

Q&A: A sudden death brings a financial quandary

Dear Liz: My son suddenly passed away and his $1-million life insurance policy was awarded to me, his mother. I want the money to be divided equally between his two children for future use. They are 18 and 15 now. What financial vehicle should I use? The funds are in my money market account just waiting to be placed into something.

Answer: Please use some of the money to pay for individualized counsel from advisors who are fiduciaries. Fiduciary means the advisor is required to put your best interests first. Most advisors are not fiduciaries but you can find financial planners who are through the National Assn. of Personal Financial Advisors, the XY Planning Network, the Garrett Planning Network and the Alliance of Comprehensive Planners.

The vehicle or vehicles you use for the money will depend on your goals and how you want to distribute the funds over time. You’ll need good advice about how to invest, minimize taxes and incorporate the money into your own estate plan. Distributing money to your grandchildren can trigger the need to file gift tax returns, although you wouldn’t actually owe gift taxes until you’d given away millions of dollars.

Your son may have chosen you as his beneficiary because he trusted you to do right by his children. Or he may not have updated his beneficiaries since applying for the policy. (More than a few ex-spouses have wound up with life insurance proceeds because the policy owner didn’t update the beneficiaries after the divorce.) It’s a good idea to check the beneficiaries on any life insurance once a year or after any major life change to make sure the money is still going where you want.

Q&A: Here’s how to pick the best retirement account

Dear Liz: Can you explain the difference between a Roth IRA and a Roth 401(k)? What are the benefits of a Roth 401(k)? My company offers it and I am considering beginning to make deferral contributions there while continuing my 401(k) contributions.

Answer: Contributions to Roth IRAs and Roth 401(k)s are after tax, which means you don’t get an upfront tax deduction as you do with traditional IRA and 401(k) accounts. But the money grows tax deferred and can be tax free in retirement.

You typically open and contribute to a Roth IRA at a brokerage, which gives you access to a wide range of investment options. Just like traditional 401(k) accounts, Roth 401(k)s are offered by an employer, usually with a limited number of investment choices.

Roth 401(k)s allow people to contribute significantly more than they could to Roth or traditional IRAs. Roth 401(k)s also allow contributions by higher earners, who might be shut out of contributing to a Roth IRA.

Roth IRA contributions are limited to $6,000 with a $1,000 catch-up contribution for people ages 50 and older. Your ability to contribute begins to phase out at certain income limits. This year, the phaseouts start at $125,000 of modified adjusted gross income for single filers and $198,000 for married couples filing jointly.

Roth 401(k)s don’t have income limits and allow you to contribute as much as $19,500 ($26,000 for those age 50 and older). That is the combined limit for elective deferrals from your paycheck. If you’re under 50 and contributing $10,000 to the pretax portion of the 401(k), for example, you could contribute a maximum of $9,500 to the Roth option.

Roth IRAs and Roth 401(k)s also have different rules for withdrawals. You can remove your contributions from a Roth IRA at any time without paying taxes or penalties. Withdrawals from a Roth 401(k) before age 59½ also can incur taxes and penalties, although you usually do have the option to take loans.

Also, you’re not required to start taking withdrawals at age 72 from a Roth IRA, as you typically are with other retirement accounts, including Roth 401(k)s. You will have the option of rolling a Roth 401(k) into a Roth IRA, typically after you leave your job, so you can avoid minimum required distributions that way.

Q&A: If you lost your job, here’s how to find free health insurance

Dear Liz: I have read that the unemployed can qualify for free health insurance through the Affordable Care Act exchanges. I’m trying to confirm whether my state, which did not accept expanded Medicaid coverage, is offering this to its residents. My position was eliminated with no warning because of the pandemic and I’m finding Healthcare.gov rather convoluted to navigate.

Answer: It may be July before the ACA exchanges reflect the extra tax credits that will make comprehensive health insurance free for anyone who receives unemployment benefits in 2021.

Some of the health insurance changes authorized by the American Rescue Plan, which President Biden signed in March, went into effect April 1. Those included providing larger tax credits that lowered costs for most people who buy health insurance on the exchanges and increasing the number of people who qualify for those premium-reducing credits.

In the past, people with incomes above 400% of the poverty line typically didn’t qualify for subsidies that lowered their costs, but now people with incomes up to 600% of the poverty line — up to $76,560 for a single person or $157,200 for a family of four — can qualify, according to medical research organization KFF (formerly Kaiser Family Foundation). The law also created a new special enrollment period that extends through Aug. 15, 2021.

The exchanges have been slower to reflect the increased tax credits for people who receive unemployment benefits at any point during 2021. These credits will effectively allow those who don’t have access to other group coverage to qualify for a free silver plan with a $177 deductible. The U.S. Centers for Medicare and Medicaid Services has promised that the credits “will be available starting this summer.”

You shouldn’t be without health insurance, so you could sign up for coverage now and update your information when the increased tax credits become available.

But you may have another option. The American Rescue Plan also requires employers to provide free COBRA coverage from April 1 through Sept. 30 to eligible former employees who lost their healthcare coverage because of involuntary termination or a reduction in hours. (Employers will get a federal tax credit to cover their costs.)

Even if you turned down COBRA coverage when you lost your job — as many people do because it’s so expensive — you could still get free coverage if it hasn’t been more than 18 months since you lost your job. Employers are required to notify eligible former employees by May 31. If you haven’t heard from yours by then but think you’re eligible, reach out to the company’s human resources department.