Q&A: When a government pension doesn’t reduce Social Security benefits

Dear Liz: I have contributed to Social Security for 40 years and have no government pension. My husband selected a reduced teacher’s pension so I would receive that same amount should he predecease me. Will my Social Security be reduced in this scenario?

Answer: No. The provisions that may reduce Social Security payments such as the government pension offset and the windfall elimination provision apply only to the person receiving the pension, not the spouse. If he dies first, your income would remain the same. If you die first, his survivor’s benefit from Social Security could be reduced or eliminated.

Q&A: This trust avoids probate (but not death and taxes)

Dear Liz: Reading your articles I understand that having a revocable living trust makes transferring wealth quicker and easier. What about taxes? If you use a will to bequeath your house, for example, the beneficiaries get a stepped-up cost basis. What are the taxes with a revocable living trust? Do you pay taxes on assets going into the trust and again going out to the beneficiaries? What are the tax advantages and disadvantages of a trust?

Answer: Many kinds of trusts have tax implications, but revocable living trusts typically don’t. Your assets get the same tax treatment as if you held them outright.

Some people mistakenly believe that revocable living trusts can help them avoid or eliminate estate taxes. The purpose of a living trust is primarily to avoid probate, the court process that otherwise follows death. In some states, including California, probate can be lengthy and expensive, which often makes a living trust worth the cost and effort to set up.

Living trusts also offer more privacy because they don’t have to be made public, unlike a will, which becomes a public record at your death. Living trusts also make it easier for your appointed person to take over for you in case you become incapacitated.

Q&A: So many credit scores — here’s how to get yours

Dear Liz: You recently discussed FICO scores. Please let me know how I can get mine. My bank says it can only give my husband his score because he is the principal on our account.

Answer: Remember that you don’t have one FICO credit score, you have many. Lenders use different versions and generations of the FICO formula. In addition, FICOs will differ based on which credit bureau was used. So your bank may give your husband a FICO Bankcard Score 2 based on information from Experian, while an auto lender might use a FICO Auto Score 5 from Equifax. These scores almost certainly will differ from his FICO 8 scores, which are the most commonly used scores. The FICOs for credit cards and autos typically are on a 250-to-900 scale, while FICO 8 is on a 300-to-850 scale.

Anyone can get free FICO 8 scores based on Experian data from Experian’s consumer site, Freecreditscore.com, and from credit card Discover at Discover.com. Several other credit card issuers — including American Express, Bank of America, Chase, Citi and Wells Fargo — offer FICOs of various kinds to cardholders.

If you want to see a broader range of your FICO scores, you can buy a three-bureau report from MyFico.com for about $60 that includes FICO 8s, FICO 9s and the most commonly used scores in mortgage, credit card and auto lending from each bureau.

Q&A: How to improve your FICO score

Dear Liz: My FICO score is just under 800. The reason given that it is not higher is that I don’t have any non-mortgage leases. What would be the cheapest way to remedy this without buying something expensive?

Answer: When you get your credit scores, you may be given sometimes-vague reasons for why they’re not higher or lower. The “reason code” you saw probably said something like “no recent non-mortgage balance information.” What that means is that you haven’t been using revolving accounts such as credit cards. To get higher scores, you’d need to dust off your plastic and use it once in a while. (You don’t need to carry a balance to get or keep good scores, however. You can and should pay credit card balances in full each month.)

Any improvement in your scores is likely to be modest, however. Your numbers are already high and the factor known as “mix of credit” — which means responsibly using both revolving and installment accounts — accounts for just 10% of your FICO scores. Plus, there’s no real point in having scores over 800, other than to brag about them. Once your scores exceed 760 or so, you’re already eligible for the best rates and terms.

Q&A: How to find the right balance when investing

Dear Liz: My brokerage wanted me to start moving from stocks that paid me steady dividends into bonds as I got older. If I’d followed that advice, I wouldn’t be nearly where I am today. I sleep just fine with my dividends. Things can change, of course, but until I see solid evidence otherwise, I am sticking with my plan. I have no idea why the brokerage is still pushing the “more bonds with advancing age” idea.

Answer: Presumably you were invested during the financial crisis and saw the value of your stocks cut in half. If you can withstand that level of decline, then your risk tolerance is a good match for a portfolio that’s heavily invested in stocks.

The problem once you retire is that another big drop could have you siphoning money for living expenses from a shrinking pool. The money you spend won’t be in the market to benefit from the rebound. This is what financial planners call sequence risk or sequence-of-return risk, and it can dramatically increase the odds of running out of money.

Perhaps you plan to live solely off your dividends, but there’s no guarantee your buying power will keep up with inflation. Most people, unless they’re quite wealthy, wind up having to tap their principal at some point, which leaves them vulnerable to sequence risk.

There’s another risk you should know about: recency bias. That’s an illogical behavior common to humans that makes us think what happened in the recent past will continue to happen in the future, even when there’s no evidence that’s true and plenty of evidence to the contrary. During the real estate boom, for example, home buyers and pundits insisted that prices could only go up. We saw how that turned out.

Bonds and cash can provide some cushion against events we can’t foresee. The right allocation varies by investor, but consider discussing your situation with a fee-only financial planner to see how it aligns with your brokerage’s advice.

Q&A: Understanding Social Security benefits

Dear Liz: I am 62. My friend (also 62) is considering when to take Social Security. She understands, from reading a finance book, that Social Security payments change only at 62, 66 and 70. She thinks if you don’t start at 62 when your benefit is, for example, $1,000, that it will stay $1,000 until age 66 when it bumps up to $1,400, or whatever. I thought that each month you delay would increase the payment you would receive. So if you get $1,000 at 62, you would get $1,005 at 62 and one month, $1,011 at 62 and two months, and so on. The Social Security site seems to support me. Can you clear this up for us?

Answer: You are correct. Your friend either misunderstood what she read or was unfortunate enough to find an author who didn’t know how Social Security works.

There are three important ages with Social Security: 62, the earliest you can begin retirement or spousal benefits; your full retirement age, which is currently 66 and rising to 67 for people born in 1960 and later; and 70, when your benefit maxes out.

Full retirement age is an important inflection point. Instead of having your checks reduced for an early start, you can begin earning delayed retirement credits that can boost your benefit by two-thirds of 1% each month, or 8% per year.

Full retirement age also marks the point at which Social Security benefits no longer are reduced if a recipient continues to work. Prior to full retirement age, benefits are reduced by $1 for every $2 earned over a certain limit ($16,920 in 2017). Also, those who started Social Security early have the option of suspending their benefits at full retirement age to allow them to begin growing again by earning delayed retirement credits. Those who suspend benefits can restart them at any time. Otherwise, suspended benefits will automatically restart at age 70.

Q&A: Capital gains taxes explained

Dear Liz: Do I understand correctly that I must live in a house for two years before selling it to avoid paying capital gains tax, regardless of how much I may profit from the sale?

Answer: You do not. You must live in a home for two of the previous five years to exempt up to $250,000 of home sale profits. (Married couples can exempt up to $500,000.) After that, you’ll pay capital gains taxes on any remaining profit.

Even if you didn’t last the full two years, you may be able to claim a partial exemption if you meet certain criteria, such as having a change in employment, a health condition or other “unforeseen circumstance” that required you to move out.

Q&A: The confusing balancing act between government pensions and Social Security benefits

Dear Liz: I am a public school teacher and plan to retire with 25 years of service. I had previously worked and paid into Social Security for about 20 years. My spouse has paid into Social Security for over 30 years. Will I be penalized because I have not paid Social Security taxes while I’ve been teaching? Should my wife die before me, will I get survivor benefits, or will the windfall elimination act take that away? It’s so confusing!

Answer: It is confusing, but you should understand that the rules about windfall elimination (along with a related provision, the government pension offset) are not designed to take away from you a benefit that others get. Rather, the rules are set up so that people who get government pensions — which are typically more generous than Social Security — don’t wind up with significantly more money from Social Security than those who paid into the system their entire working lives.

Here’s how that can happen. Social Security benefits are progressive, which means they’re designed to replace a higher percentage of a lower-earner’s income than that of a higher earner. If you don’t pay into the system for many years — because you’re in a job that provides a government pension instead — your annual earnings for Social Security would be reported as zeros in those years. Social Security is based on your 35 highest-earning years, so all those zeros would make it look like you earned a lower (often much lower) lifetime income than you actually did. Without any adjustments, you would wind up with a bigger check from Social Security than someone who earned the same income in the private sector and paid much more in Social Security taxes. It was that inequity that caused Congress to create the windfall elimination provision several decades ago.

People who earn government pensions also could wind up with significantly more money when a spouse dies. If a couple receives two Social Security checks, the survivor gets the larger of the two when a spouse dies. The household doesn’t continue to receive both checks. Without the government pension offset, someone like you would get both a pension and a full survivor’s check. Again, that could leave you significantly better off than someone who had paid more into the system.

Q&A: You don’t need to carry debt in order to have good credit

Dear Liz: You should tell people that they can help their credit score more by not paying their credit card bills in full each month. By not paying in full, but paying the minimum or more each month, it shows the card issuer that you can handle credit wisely and encourages them to raise the limit. This pushes the utilization down.

Answer: There’s nothing wise about carrying credit card debt. The idea that you need to carry a balance to have good scores is a stupid, expensive myth that needs to die.

People who spread this myth don’t understand how balances are reported to the credit bureaus and subsequently used in credit scores. Credit card issuers typically don’t report your balance on the day after you pay your bill. They may report your last statement balance, or the balance on a certain day each month. That’s the balance that credit score formulas have long used to calculate your scores. The scoring formulas traditionally couldn’t see whether or not you carried a balance from month to month, so there was no reason to do so and incur expensive interest.

Recent credit reporting changes will make carrying a balance an even worse idea. Some card issuers have started reporting payment patterns — essentially telling the bureaus which people consistently pay their balances in full and which don’t. That’s because research has shown that people who pay off their credit card bills are significantly less likely to default than those who carry a balance. Mortgage lenders already are considering this information when making loans, even though it’s not something that factors into the credit scores most of them currently use.

Although there’s no advantage to carrying a balance, there is a huge advantage to lightly but regularly using the credit cards you have. That’s what actually shows scoring formulas and lenders that you can responsibly manage credit.