May 3, 2021 By

Q&A: What to consider before taking a lump sum

Dear Liz: I had a pension from a previous employer that was going to pay me $759 per month at 65. They offered me a lump-sum buyout about five years ago of around $65,000. I ran the numbers and decided that was definitely not enough money and declined.

Then last year they upped the offer and the new lump sum amount was $125,000. I ran the numbers again and this time decided to grab the money and roll it into an IRA. I’m 63 and plan to retire at 70. I can hopefully grow that $125,000 to $250,000 by that time, which would give me that much more to live on, plus it gives me more discretion on using that money than just getting the monthly payment the pension would have paid me.

After reading one of your latest columns, I am now questioning whether I made the right decision to take the lump sum.

Answer: There are a number of good reasons for opting for a lump sum versus an annuity. For example, people with large pensions may not be fully protected by the Pension Benefit Guaranty Corp. if their pension fund fails. Others may need more flexibility than an annuity offers.
But a pension is typically money that’s guaranteed for life, in good markets and bad. If you’re choosing the lump sum just because you think you can earn better returns, you need to consider how you’ll protect yourself and your spouse from fraud, bad decisions and bad markets.

Bull markets can lull people into thinking they’re good investors, but markets can go down and stay down for extended periods. That poses a special risk to retirees, who are at increased risk of running out of money when they draw from a shrinking pool of investments. Even a short bear market can cause problems, while an extended one can be disastrous.

You’ll also want to consider how you’ll manage when your cognitive abilities begin to decline. Our financial decision-making abilities peak in our 50s, but our confidence in our abilities tends to remain high even as our cognition slips. That can lead to bad investment decisions and increased vulnerability to fraud.

Finally, consider your spouse. If you die first, will your spouse be comfortable managing these investments? If not, is there someone in place who can help?

A fee-only financial planner could discuss these issues with you and help you create a plan to deal with them.

Filed Under: Q&A, Retirement Tagged With: , ,
April 26, 2021 By

Q&A: Protecting home sales proceeds from taxes

Dear Liz: My friend has been diagnosed with Alzheimer’s and is now living in a secure assisted living facility. After a year in this home, his sister finally sold his condo. Her tax person says he will take a big tax hit. I say it is totally medically ordered and he’ll need the money for his current housing ($5,000 a month) until he dies. I also question whether part of that $5,000 should be deductible because it is only ordered because of his illness. Your thoughts?

Answer: Your friend may not be able to protect all of his home sale proceeds from taxation, but he likely will be able to protect some.

If your friend lived in his condo for at least two of the previous five years before the sale, he will be able to avoid tax on up to $250,000 of home sale profits. Even if he fell short of the two-year mark, he likely would benefit from IRS rules that allow partial exemptions when the sale is due to “unforeseen circumstances.”

Meanwhile, medical expenses, including some long-term care expenses, are potentially deductible if they exceed 7.5% of someone’s adjusted gross income. Assisted living expenses may qualify as deductible medical expenses if the resident is considered chronically ill, which means they cannot perform at least two activities of daily living (eating, toileting, bathing, dressing, getting in and out of bed and remaining continent) or they require supervision because of cognitive impairment, such as Alzheimer’s disease or other forms of dementia. The personal care services must be provided according to a plan of care prescribed by a licensed healthcare provider. Typically, assisted living facilities prepare such care plans for their residents.

Filed Under: Q&A, Real Estate, Taxes Tagged With: , ,
April 26, 2021 By

Q&A: A 401(k) versus an IRA: Which one wins this smackdown?

Dear Liz: I am a 27-year-old with a big investment question. The company I work for matches 401(k) contributions up to 9%, which is all well and fine since I contribute enough to receive the company match. I have just about $60,000 in my 401(k) and I have a Roth IRA on the side as well as a brokerage account for stocks. I would like to roll over my 401(k) into another IRA since the investment choices in the 401(k) are rather limited. I’m a big fan of investment diversification with different funds. Is this a good option to choose or is this a silly idea with no merit? I understand the tax implications involved but am willing to bite the bullet for more investment options.

Answer: Good for you for being so diligent about saving for retirement. Your early start should give you a lot of options when you’re older.

For now, your question has an easy answer. Typically, you can’t roll a 401(k) account into an IRA while you’re still working for the employer that provides the 401(k).

There are a few exceptions. Once you turn 59½, some plans do allow such rollovers. Also, a few plans offer “mega backdoor Roths” that allow you to contribute after-tax money to a 401(k) and then do an “in service” conversion to a Roth IRA. This option helps high-income people get around the income limitation that would otherwise prevent them from contributing to a Roth IRA.

You will have the option of rolling your money into an IRA once you leave your job, but don’t assume such a rollover is always the right choice.

Most 401(k)s offer enough options to give you plenty of diversification, plus you may have access to low-cost institutional funds that wouldn’t be available in an IRA. You’re also protected by federal law that requires the companies offering 401(k)s to act as fiduciaries — in other words, they must put your best interests first. You often have the option of rolling your 401(k) balance into a new employer’s plan, which means you would be able to take loans from the plan. That’s not an option with an IRA.

There are no tax implications for rolling over a 401(k), by the way. Only if you convert the money to a Roth IRA will you owe taxes. A conversion may make sense, but you’ll want to talk to a tax pro first.

Filed Under: Q&A, Retirement Tagged With: , , ,
April 19, 2021 By

Q&A: Pension: to lump or not to lump

Dear Liz: I’m 67 and I’m going to retire later this year. My wife is already retired, and our kids are grown and on their own. I have a 401(k) that I’ve contributed to for most of my working years, and a small traditional IRA. I also have a grandfathered pension plan through my employer. I’m leaning toward taking the pension benefits as a lump sum and rolling it directly to either my 401(k), which my company allows, or my IRA. Would you recommend using the 401(k) to receive the pension rollover? Or would the IRA be the better choice?

Answer: Before you decide where to put the lump sum, please reconsider taking a lump sum in the first place.

Pensions are normally taken as a stream of monthly payments that last for the rest of your lives. (You may be offered a “single life only” option that ends when you die, but that could leave your wife without enough to live on, so the “joint and survivor” option is typically better.) You can’t outlive this money, fraudsters can’t steal it and you won’t lose it to bad markets or bad investment decisions. Most pensions are protected by the Pension Benefit Guaranty Corp., so even if the plan goes broke, your payments will continue.

Contrast that with the lump sum. Theoretically, you may be able to invest the money and get a better return than what you would get from the annuity option (the monthly payments). But that’s far from guaranteed, and one misstep could leave you far worse off.

There are a few situations where taking a lump sum may be smart. If the pension plan is woefully underfunded, and your benefit would not be entirely protected by the PBGC, you could take the lump sum and either invest it or buy an immediate annuity that would replicate those guaranteed monthly payments.

Filed Under: Q&A, Retirement Tagged With: , ,
April 19, 2021 By

Q&A: She counted on pandemic rent relief but didn’t qualify. Now what?

Dear Liz: I have a friend in dire financial straits. She has borrowed from her retirement, spends too much and didn’t pay her rent thinking she would get pandemic relief, but she makes too much to qualify for emergency rental assistance. She has mental health issues, which are being addressed by a therapist, but I would love to offer her financial counseling services as well. She is in her late 50s and desperately depressed over this. It’s hard to stand by when the rest of our friend group is doing well, and we’re not sure how to direct her. I would possibly be willing to pay for a financial counselor but will not “loan” her money because that is a losing proposition.

Answer: Congress approved nearly $50 billion in emergency rental assistance to help pay back rent and utilities for low-income people impacted by the pandemic. The key phrase is “low income.” The help isn’t available for people who earn more than 80% of the area’s median income, and many programs are limiting the aid to those with incomes below 50% of the median. The aid is being distributed through more than 100 state and local agencies, and more programs are on the way. The National Low Income Housing Coalition is keeping a list.

Currently, landlords are mostly prohibited from evicting non-paying tenants, but eviction moratoriums will someday end. Your friend could find herself not just turned out of her home but unable to rent decent housing, since many landlords won’t consider anyone who’s been evicted. Avoiding that fate needs to be a top priority for her.

Nonprofit credit counseling agencies, such as those affiliated with the National Foundation for Credit Counseling, offer a variety of low-cost or free services that may help your friend, including housing counseling, budgeting help and debt management plans. She also should consider discussing her situation with a bankruptcy attorney.

Her depression may make it difficult for her to take action, so you could help her make the appointment and even offer to accompany her. Ultimately, of course, it will be up to her to make the necessary changes, but supportive, nonjudgmental friends could be an enormous help.

Filed Under: Credit & Debt, Q&A Tagged With: , ,
April 12, 2021 By

Q&A: Maxing out retirement benefits

Dear Liz: I turn 70 in July. Will I need to wait to start my Social Security benefits until 2022 to receive my full benefit, or can I start them in August 2021?

Answer: There’s no need to wait to claim your benefits once they max out at age 70. If you did apply late, you could get a maximum of six months of retroactive benefits but no more.

Filed Under: Q&A, Retirement Tagged With: ,
April 12, 2021 By

Q&A: Filing taxes after a spouse’s death

Dear Liz: I am writing this email on behalf of my 88-year-old dad. He wanted to ask you this question: “My wife passed away Jan. 7, 2020. In filing my 1040 income tax for 2020, am I allowed to file as a married couple or required to file as a single person?”

Answer: Your dad can use “married filing jointly” with his deceased spouse for the year of her death, assuming he didn’t remarry in that year.

If your dad claimed one or more qualifying dependents — a child, stepchild or adopted child — he might be able to file as a qualifying widower for the following two years as long as he paid more than half the cost of maintaining his home and it was the main home of the dependent or dependents. Most people your dad’s age no longer live with their kids or claim them as dependents on their tax returns. But if he did, this could preserve the larger standard deduction and other benefits of filing jointly for another couple of years.

Filed Under: Q&A, Taxes Tagged With: , ,
April 12, 2021 By

Q&A: Paying taxes with plastic

Dear Liz: I am selling a rental property that I have owned for several years. I know I could do a 1031 exchange, which would allow me to put off the tax bill by investing in another commercial property. But I just want out. I’ll pay the capital gains tax and invest the rest of the proceeds. I am considering paying the taxes by credit card and taking on the 3% premium to get rewards points offered through the card issuer. Is this a dumb idea, or does it have some merit?

Answer: The companies that process federal tax payments have processing fees of just under 2%, not 3%. You’ll still want to make sure you get more value from your rewards than you pay in fees, and that’s not a given. If your card offers only 1.5% cash back, for example, charging your taxes doesn’t make a lot of sense. But the math changes if you can get more than 2% in rewards, or if you could use the charge to help you meet the minimum spending requirements for a new credit card with a generous sign-up bonus.

If you do charge your taxes, you’ll obviously want to pay the balance in full before incurring any interest.

Filed Under: Credit Cards, Q&A, Taxes Tagged With: , , ,
April 12, 2021 By

Q&A: Refreshing an old credit card

Dear Liz: I have and use three credit cards, two of which offer cash-back rewards. The third has no rewards program, so I would like to get rid of it and replace it with a new card that offers cash back or miles. But I’m afraid if I cancel this card my credit score will take a hit, especially since the card has a big chunk of my overall credit limit. What do you suggest?

Answer: You can ask the issuer for a “product change,” which allows you to swap one card for another without closing your account. Typically, your history with the old card is simply transferred to the new one, as is your credit limit.

The new card must be from the same issuer and you usually won’t qualify for any sign-up bonuses. But you won’t risk damaging your scores by closing one account and applying for another.

Research the issuer’s offerings and know which card you want before you call. This is usually a fairly routine process, but if you encounter any resistance, just mention that your other option is to cancel the card. If you’ve been a good customer, the issuer probably will want to keep your business.

A product change also can be a good idea if you want to switch from a rewards card with a high annual fee to one with a lower fee, or no fee. Any rewards you’ve already earned may not be transferable, so be sure to ask.

Filed Under: Credit Cards, Q&A Tagged With: , ,
April 12, 2021 By

Q&A: Don’t file an amended return after the stimulus tax break. The IRS is begging you

Dear Liz: You might want to inform your readers that they do not need to file an amended return if they filed before Congress passed its most recent stimulus plan, which excludes the first $10,200 of unemployment benefits. The IRS will automatically recalculate their taxes and refund the taxes paid on that amount of benefits.

Answer: In fact, the IRS is begging people not to file amended returns. (An exception, the IRS has said, is for those who the tax reduction would make newly eligible for the earned income tax credit or other tax breaks for lower income people.) The agency is still processing a backlog of returns and correspondence while issuing a third wave of stimulus payments and gearing up to send monthly child credit payments to millions of families.

You may need patience, however. The IRS has promised to refund any taxes paid on the first $10,200 of unemployment benefits earned last year, but has said the money will go out “this spring and summer.”

Filed Under: Q&A, Taxes Tagged With: , , ,