Q&A: Deferred compensation plans

Dear Liz: I’m 54 and plan on retiring at 55 with a government pension. I have about $450,000 in a 457(b) deferred compensation plan. I owe about $220,000 on my home. I would like to pay off my 15-year, 2.5% interest mortgage. This would free up $1,900 a month and leave us debt-free. Everyone I’ve spoken to says this is a bad idea since I’d lose my mortgage interest deduction and I’d be “investing” in a low-interest vehicle (my mortgage). My only other obligation is my daughter’s college education, and I’m paying that in cash. Am I crazy to pay off this mortgage?

Answer: You’re not crazy, but you probably haven’t thought this all the way through.

The money in your deferred compensation plan hasn’t been taxed. Withdrawing enough to pay off your mortgage in one lump sum would shove you into a higher tax bracket and require you to take out considerably more than $220,000 to pay the tax bill. You could easily end up paying a marginal federal tax rate of 33% plus any applicable state tax — all to pay off a 2.5% loan.

There are a few scenarios where using tax-deferred money to pay off a mortgage can make sense. Some people have so much saved in retirement plans that the required minimum distributions at age 70½ would push them into high tax brackets and cause more of their Social Security to be taxed. They also may have paid down their mortgage to the point where they’re no longer getting a tax break.

In those instances, it may be worth withdrawing some money earlier than required to ease the later tax bill. The math involved can be complex, though, and the decisions are irreversible, so anyone contemplating such a move should have it reviewed by a fee-only financial advisor who is familiar with these calculations.

In fact, it’s a good idea to get an objective second opinion from a fiduciary any time you’re considering tapping a retirement fund. (Fiduciaries are advisors who pledge to put your interests ahead of your own.)

During your meeting, you also should review the other aspects of your retirement plan. How will you pay for health insurance in the decade before you qualify for Medicare? If you’re a federal employee, you should be eligible for retiree health insurance but your premiums may rise once you quit work. If you’re planning to buy individual coverage through a healthcare exchange, what will you do if that’s yanked away or becomes unaffordable? How will you pay for long-term care if you need it, since that’s not covered by health insurance or Medicare?

You can get referrals to fee-only financial planners from the National Assn. of Personal Financial Advisors at napfa.org. You can find fee-only planners who charge by the hour at Garrett Planning Network, garrettplanningnetwork.com.

Q&A: Too many cards?

Dear Liz: My husband and I have opened accounts to take advantage of 0% interest financing for special purchases. These accounts are paid in full prior to the end of the promotional period and we don’t use them again. I’ve read to not ever close any accounts, but am nervous about having so many accounts open with such high limits. Is there potential for issuers to stop granting us credit because we have so much available? Are we at greater risk for identity theft with all of these open accounts?

Answer: People used to believe that closing accounts could somehow help their credit scores. Credit scoring companies and experts have done their best to combat that myth, but in doing so have left some people thinking that they can’t ever close unneeded accounts. That’s not true either.

Your credit scores won’t be hurt by having “too many” accounts with high limits. That’s generally a good thing, since multiple lenders have deemed you creditworthy. You get the most credit scoring benefit, though, from accounts you’re actively using.

Leaving unused accounts open can leave you more vulnerable to fraudulent account takeover. At the very least, it adds to the hassles in your life, since you have to keep an eye on all your accounts. And conceivably a lender could balk at seeing a lot of unused credit lines, even if it didn’t hurt your scores.

You don’t want to close accounts if you’re trying to improve your scores or in the market for a major loan, such as a mortgage or auto loan. Otherwise, though, you shouldn’t worry about closing an account now and then if you’re not using it.

Q&A: Social Security benefits for spouses can pump up household income

Dear Liz: I have a friend who has a selfish, controlling husband. When talking with her recently, she told me she got only $300 a month from Social Security based on her work history while her husband gets $1,800. I told her she should be getting $900, half of his monthly amount, as a spousal benefit. I guess he thought if she got more it would reduce his check. I told her the $900 would be in addition to the $1,800 he gets.

She has been collecting her smaller benefit for seven or eight years. Does she have any recourse? I doubt he would take her to the Social Security office but maybe her daughter would.

Answer: It sounds like the husband’s greed has cost this household tens of thousands of dollars in lost benefits.

Spousal benefits (and divorced spousal benefits) do not reduce the primary worker’s check. This benefit, as you correctly told your friend, is available in addition to what her husband gets. Spousal and divorced spousal benefits can be up to half of the primary worker’s benefit. The amount that spouses and divorced spouses get is reduced if they start benefits before their own full retirement ages.

Your friend can’t get back the years of benefits she missed out on, but she should ask the Social Security Administration to switch her to the larger benefit. She can contact the administration at 1-800-772-1213.

The death of a student loan co-signer could have financial ramifications for the borrower. (Colleen Riemer / For The Times)

Q&A: When a student loan co-signer dies

Dear Liz: I have a friend who recently died after co-signing a student loan for her son. She was making the payments. Does that loan go to her son now to repay?

Answer: Possibly. Another possibility is that her estate is on the hook.

It all depends on the loan agreement, which varies from private lender to private lender. (We know this is a private loan because federal student loans, which have many more consumer protections, do not require co-signers.)

In many cases, nothing happens if the other borrower takes over the payments and continues to make them on time. Some lenders, however, have a contract clause that makes the balance of the loan due immediately. In the past, lenders also could consider a death to be an “automatic default” that could seriously damage the living borrower’s credit. Fortunately, the Consumer Financial Protection Bureau pushed lenders to change their policies on new and existing loans so that co-signer deaths no longer trigger such defaults.

If you’re close to this young man, you should urge him to check the contract and to contact the lender.

Q&A: Deducting medical expenses racked up by another person

Dear Liz: I recall reading that an individual could deduct unlimited medical expenses for another person, as long as the provider was paid directly. Looking at IRS Publication 502, it appears that now only a “qualifying relative” (the closest I could get to eligibility) is eligible for a deduction on another person’s return. I’m asking because my sister is helping with my medical expenses, and I had hoped to give her a deduction. Her tax person is insistent that she cannot take a deduction for my expenses. I don’t qualify under the “qualifying relative” clause because she doesn’t provide more than half my support. Have I always misinterpreted this rule, or has the rule changed recently?

Answer: You’re confusing the medical deduction rules with the gift tax exemption.

The gift tax rules require givers to file tax returns for gifts in excess of $14,000 per recipient, unless the giver paid medical or tuition expenses directly to a provider (such as a hospital or college). Paying these expenses isn’t considered a gift, so your sister can pay an unlimited amount of your medical bills without having to file a gift tax return or counting those gifts toward her lifetime exclusion amount, which is currently $5.49 million. Gift taxes aren’t owed until that lifetime exclusion amount is exceeded.

Your sister can deduct medical expenses from her income taxes only when she pays them on behalf of herself, her spouse, her dependents and her “medical dependents.” Claiming someone as a dependent or medical dependent requires that she provide at least half that person’s support. Only the amount of qualifying medical expenses that exceed 10% of her adjusted gross income in 2017 would be deductible.

Q&A: Why a reverse mortgage might be a good idea for some older homeowners

Dear Liz: I recently retired to a small house I bought 30 years ago. I refinanced four times to get the rate down from 11% to 3.5%. This provided me with a low monthly mortgage (just under $450), but my current 30-year loan won’t be paid off until I’m 92. I’ll be 67 in two months, and just received an inheritance of $400,000 following the death of my parents. My only income is $2,000 a month from Social Security and a monthly pension check of $1,100, although I do have an IRA that should be worth roughly $170,000 by July.

I’m thinking about paying off the $90,000 remaining on my mortgage, which would allow it to be passed on to my sister, nephew (or whomever) without any complicated bank or loan issues. It also would free up that mortgage payment for other household expenses. The house needs some work, such as a new carport, double-pane windows, proper insulation, deck repair and maybe termite work, all of which will probably eat up the better part of $100,000. Is it worth keeping the loan just to maintain the tax deduction or does it makes financial sense to pay it off?

Answer: Keeping a mortgage just for the tax deduction doesn’t usually make much sense. Here’s why: If you’re in the 25% federal tax bracket, you’re getting back only about 25 cents for each dollar in interest you pay. Most homeowners get even less back, and many don’t get any tax advantage from their mortgages at all.

It can make sense, though, to keep a mortgage to preserve liquidity. Younger people, especially, should be wary of tying up most of their net worth in a home if that equity would be hard to tap in an emergency. Home equity lines of credit offer one way to access that equity, although lenders can freeze or reduce those lines on a whim.

Because you’re over 62, you could consider paying off the loan and then setting up a reverse mortgage line of credit.

An FHA-insured reverse mortgage line of credit can’t be shut down once it’s established, as long as you abide by the loan rules (such as paying your property taxes and insurance, and keeping the home in good condition). In fact, the amount you can borrow can increase over time with a reverse mortgage credit line. You don’t have to make monthly principal and interest payments on the money you borrow with a reverse mortgage.

Any amount you borrow will grow over time, typically at variable interest rates, and will have to be repaid when you die, sell or permanently move out of the home. That would complicate leaving the house to your heirs, but if the amount you owe is greater than the home’s worth, your heirs aren’t on the hook for the difference with an FHA-insured reverse mortgage, also known as a Home Equity Conversion Mortgage.

In any case, preserving an inheritance probably shouldn’t be your top priority. You should focus instead on preserving your quality of life and your financial flexibility.

Reverse mortgages have gotten safer and less expensive in recent years, but you would need to exercise discipline not to waste the money you borrow on frivolous purchases. You want that equity to be available for you when you need it, such as for nursing home or other long-term care expenses.

You would be required to get counseling before applying for a reverse mortgage, but you also should talk to an independent, fee-only financial planner to make sure this approach makes sense.

Q&A: When generosity becomes a taxing issue

Dear Liz: I recently came into some money, and I would like to share it with my family. I understand that there are annual tax caps on how much you can give to someone ($14,000 per person per year). However, does this limit apply only to cash and cash equivalents or also to any other gifts? For instance, can I pay off a sibling’s student loan for more than $14,000 without running afoul of the limits?

Answer: There’s no cap on how much money you can give to another person. But if you give more than $14,000 to any one person, you have to file a gift tax return (IRSForm 709). You won’t actually owe gift taxes until the amount you give in excess of that limit totals more than $5 million. (The precise limit this year is $5.49 million and it’s scheduled to rise by the rate of inflation in coming years.)

Paying most bills, including student loans, on behalf of another person counts as part of that $14,000 limit. The only exceptions are if you pay someone’s tuition, medical expenses and health insurance. To avoid the limit, you would have to pay the bills directly to the provider (such as the school, doctor, hospital, insurance company and so on). If you give the money to the person to pay these expenses, it counts as part of the $14,000 exemption.

Some people keep rigidly to the $14,000 limit to avoid having the excess gifts reduce their estate tax exemption. (Gifts over the $14,000 limit are added back into a person’s estate at death, and the prevailing estate tax exemption — which is also currently $5.49 million — is deducted from that enhanced total.)

If you aren’t a multimillionaire, though, this probably isn’t something you need to worry about. If you go over the $14,000 per person limit, you just have to deal with a little paperwork.

Q&A: How one spouse’s bankruptcy filing affects the other spouse

Dear Liz: If one spouse files for bankruptcy, how does that affect the other spouse? What happens to the joint accounts?

Answer: How the nonfiling spouse is affected depends on whether they live in a community-property or a common-law state.

Most states are common-law states. Property and debts acquired during marriage can belong to only one spouse.

In these states, the filing spouse’s separate property and their share of any jointly owned property become part of the bankruptcy. Any property that isn’t protected under the state’s bankruptcy exemption laws can be taken and sold to pay creditors.

The bankruptcy trustee may try to partition any joint property so only the filing spouse’s share is sold, but if that’s not possible the whole property may be sold and the nonfiling spouse will be paid for his or her share. The bankruptcy erases the filing spouse’s separate debts and share of any joint debts, but the nonfiling spouse still has to pay his or her share of those joint debts.

In community-property states, property and debts acquired during marriage typically belong to both spouses, even if they’re in only one spouse’s name. So a bankruptcy filing by one spouse in a community property state can put more property at risk. (Community-property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.)

As in common-law states, a completed bankruptcy erases the filing spouse’s debts but leaves the other spouse on the hook for his or her share of any joint debts.

In community-property states, though, the nonfiling spouse can get a benefit known as a “phantom discharge.” If the filing spouse gets debts wiped out and is able to protect community property under the state’s exemption laws, then that property stays protected. As long as the couple is married, creditors won’t be able to touch it.

Bankruptcy has gotten complicated enough that you’ll want to get good, solid advice from an experienced bankruptcy attorney before you proceed with any filing. Most such attorneys offer a free or low-cost initial consultation to discuss whether it’s the right solution for your situation. You can get referrals from the National Assn. of Consumer Bankruptcy Attorneys at www.nacba.org.

Q&A: Money in the bank isn’t safe from inflation

Dear Liz: I am 68 and not in very good health due to heart disease. I’m not sure what do with my savings of over $1 million, which sits in online bank accounts, earning 1.25% to 1.35% in 18-month certificates of deposit. (No account contains more than $250,000 to remain under the FDIC insurance limits.) The money will eventually go to my daughter, though I could use it for my retirement. I don’t have the appetite for market swings. What should I do with my money?

Answer: Your money currently is safe from just about everything except inflation. If you want to keep your nest egg away from market swings, you’ll have to accept that its buying power will shrink. There is no investment that can keep your principal safe while still offering inflation-beating growth.

If you do want a shot at some growth, you could keep most of your savings in cash but also invest a portion in stocks — preferably using low-cost index mutual funds or ultra-low-cost exchange-traded funds.

Before you know how to invest, though, you’ll need to think about your goals for this money. A fee-only financial planner could help you discuss the possibilities and come up with a plan. You can find fee-only planners who charge by the hour through the Garrett Planning Network, www.garrettplanningnetwork.com.

Q&A: Good reasons why one spouse’s inheritance doesn’t belong to the other

Dear Liz: You recently told a husband who wanted to spend his wife’s expected inheritance that the money would be her separate property. Is that true of all states or just community property states like California? Even if it can be kept legally separate, should it be? Isn’t it better for couples to share their money?

Answer: Inheritances and gifts are considered separate property in every state. Where community property and equitable distribution states differ is in how other assets and debts acquired during marriage are treated.

For inheritances and gifts to remain separate property, though, a recipient must be careful not to commingle them with joint funds. Recipients would need to keep such windfalls in separate bank or brokerage accounts in their names alone, for example, rather than storing the money in jointly held accounts, using it to improve a jointly owned asset such as a home or paying down a joint obligation such as a mortgage.

Why would people want to keep funds separate? There are good reasons, even in marriages where all other money is shared. The couple may divorce, or the wife could die before her husband. If she commingles her inheritance with joint funds, the money her mother intended her to have could ultimately get spent by her husband’s next wife.

The wife may well decide to share some or all of her windfall with her husband. But she shouldn’t be pressured or bullied into doing so, especially with the notion that it’s the “right” thing to do. She would be smart to talk — alone — to a fee-only financial planner who pledges to put her interests first before she makes any decisions about the money.