Q&A: Credit alert or phishing scam?

Dear Liz: I received a notice from one of my credit card companies stating that they had noticed something amiss in my credit, though not related to their card. The notice suggested I check my credit reports, which I did. Nothing showed up on the reports that was of concern. What else should I do to ensure my credit stays secure?

Answer: Vague “alerts” are a hallmark of phishing emails that are trying to get you to reveal personal information.

If you followed a link in an email to view your credit reports or accessed them on any site other than www.annualcreditreport.com, you may well have handed your Social Security number and other vital data to an identity thief.

If that’s the case, you should freeze your credit reports to prevent the thief from opening new accounts in your name. You might want to do that anyway, given the prevalence and severity of recent database breaches.

Q&A: Does a credit freeze hurt your credit scores?

Dear Liz: I implemented a credit freeze a few months ago. I’m wondering if that could prevent me from having credit scores. I understand that if you don’t use credit, your credit scores can basically go away. I don’t have any loans or a house payment. I do have a few credit cards, used often and paid in full monthly.

Am I at risk of my credit fading away because of neglect with the freeze in place?

Answer: You’ll continue to have credit scores as long as you keep using credit accounts that are reported to the major credit bureaus. The people who are at risk of having their credit die of neglect are the ones who stop using credit.

About 7 million people are considered “credit retired,” which means they no longer actively use credit enough to generate credit scores, according to credit scoring company FICO. Their histories are free from charge-offs and other negative marks that might indicate their lack of credit is involuntary, says Ethan Dornhelm, FICO’s vice president for scores and predictive analytics.

Being credit retired can be costly. People may be shut out of loans they want in the future, or may have to pay higher interest rates. A lack of scores could lead to higher insurance premiums, cellphone costs and utility deposits.

Keeping your credit scores alive is relatively easy — using a single credit card is enough. There’s no need to carry debt or pay interest. Just continue using the card lightly but regularly, and pay it off in full every month.

Your credit freezes will prevent new lenders from seeing your scores and opening new accounts in your name unless you thaw the freezes. Companies where you already have an account, however, will be able to see your reports and scores.

Q&A: Giving stock to your children

Dear Liz: We plan to give our children some stock that we have had for several years. What is the tax consequence when they sell it? Is it the difference from the value when we gave it to them till they sell it, or the difference from the value when we purchased it?

Answer: If the stock is worth more the day you give it to them than it was worth when you bought it, you’ll be giving them your tax basis too.

Let’s imagine you bought the stock for $10 per share.

Say it’s worth $18 per share when you gift it. If they sell for $25, their capital gain would be $15 ($25 sale price minus your $10 basis). They will qualify for long-term capital gains rates since you’ve held the stock for more than a year.

If on the day you give the stock, it’s worth less than what you paid for it, then different rules apply. Let’s say the stock’s value has fallen to $5 per share when you gift it.

If your children later sell for more than your original basis of $10, then $10 is their basis. So if they sell for $12, their capital gain is $2.

If they sell it for less than $5 (the market value when you gave it), that $5 valuation becomes their basis. If they sell for $4, then, their capital loss would be $1 per share ($4 sale price minus $5 basis). The silver lining: Capital losses can be used to offset income and reduce taxes.

Finally, if they sell for an amount between the value at the date of the gift and your basis — so between $5 and $10 in our example — there will be no gain or loss to report.

If, however, you wait and bequeath the stock to them at your death, the shares would get a new tax basis at that point. If the stock is worth more than what you paid, your kids get that new, higher basis. So if it’s worth $25 on the day you die and they sell for $25, no capital gains taxes are owed. If it’s worth $5 when you die, though, the capital loss essentially evaporates. Your kids can’t use it to offset other income.

Q&A: If your job reimburses you for education costs, can you still get a tax deduction?

Dear Liz: I established a Coverdell Education Savings Account for my son about 20 years ago. My son has since graduated, and there is still about $12,000 left in that account. He has worked a few years and now is going to graduate school while still being employed. His employer will do education reimbursement.

How should we withdraw the funds to qualify for the education expense deduction come tax time?

Answer: Congress recently eliminated the tuition and fees deduction, but the American Opportunity Tax Credit and the Lifetime Learning Credit remain for 2018. For you to claim an education credit, however, your son would have to be your dependent. If your son is working full time, he’s probably not a dependent. He may be able to take a credit, but only for qualified education expenses that aren’t reimbursed by his employer or paid by a Coverdell distribution. Taxpayers aren’t allowed to double-dip — or potentially, in this case, triple-dip — on education tax benefits.

If your son incurs education expenses in excess of what his employer reimburses, then funds in the Coverdell ESA could be used to pay for those costs or reimburse your son for the additional out-of-pocket education expenses he paid in the same year as the distribution, said Mark Luscombe, principal tax analyst at Wolters Kluwer Tax & Accounting. Once the Coverdell is depleted, your son may be able to take a credit for any remaining qualified education expenses.

Q&A: Selling a home you’ve shared with tenants

Dear Liz: I am 53 and own a home in which I live and rent out rooms. Every year I pay my taxes on the rental income and get to deduct depreciation.

How does this affect the taxes I will pay on the home when I sell it? Will I be able to claim the $250,000 exemption? I may live in this home until my death and leave it to my children. How would the rental depreciation affect their stepped-up basis and any taxes they might have to pay?

Answer: Renting rooms is similar to taking the home office deduction in the Internal Revenue Service’s eyes. In both cases, you have to recapture any depreciation, but the business use doesn’t affect your ability to take the home sale exclusion.

The home sale exclusion allows you to exempt from capital gains taxes up to $250,000 of home sale profit. (The exclusion is per owner, so a married couple potentially could exempt up to $500,000.) You’re eligible for the exclusion if you have owned and used your home as your primary residence for at least two years out of the five years before the sale. You will have to pay income taxes on the amount of depreciation you deducted over the years. That depreciation amount is added back as income on your tax return.

If the space you rented out had not been within your living area — if it were a separate apartment or retail space — then different rules would apply.

If you decide to bequeath the home at your death rather than selling it, your heirs won’t have to pay the depreciation recapture tax — or capital gains taxes on any appreciation that took place while you owned it. Instead, the home’s tax basis will be “stepped up” to its current market value.

If they sell it soon after inheriting it, they won’t owe much if any tax on the sale. If they hang on to it before selling, they’ll owe taxes only on the appreciation that took place while they owned it. If they move in and make it their primary residence, they too could qualify for the $250,000-per-person home sale exclusion once they have owned the home, and used it as their primary residence, for at least two of the five years before they sell it.

Q&A: Social Security spousal benefits

Dear Liz: I’m remarried and don’t plan to claim a spousal benefit on my husband’s Social Security, as my benefit will be four times what his will be. My previous marriage ended in divorce at 10 years, and my ex died two years ago. How do I find out if I’m eligible to collect on my ex’s Social Security record? I am 63 and want to wait until 70 to apply for my own benefit, but I would like to retire at the end of this year.

Answer: You’ve already cleared one hurdle, which is that your previous marriage lasted 10 years. So whether you qualify for divorced survivor benefits depends on how old you were when you remarried.

Divorced people who remarry after they reach age 60, or age 50 if they’re disabled, can qualify for divorced survivor benefits. Those who remarry before that point are out of luck.

Note, please, that the remarriage rule applies only to survivor benefits. Spousal benefits are a different story. While divorced people can qualify for spousal benefits if their marriages lasted at least 10 years, the ability to get a spousal benefit ends when they remarry.

Survivor benefits are also different from spousal benefits in that you will be free to switch from a survivor benefit to your own benefit at 70. When you apply for spousal benefits, you typically have to apply for your own benefit at the same time and will get the larger of the two. You can’t switch to your own benefit later.

Q&A: If you’re putting money in a 401(k) and an IRA at the same time, be ready for the taxes

Dear Liz: I recently returned to a regular 9-to-5 job after freelancing for several years. I contributed the maximum amount to an IRA while self-employed and continued to do so after starting my new job. I was surprised to learn when doing my taxes this year that I could not deduct my IRA contributions because I was also contributing to my company’s 401(k) plan.

Other than increase my 401(k) contributions at the expense of future IRA funding, are there any actions I can take?

Answer: The ability to deduct IRA contributions when contributing to a workplace retirement plan phases out once your modified adjusted gross income reaches certain limits. For single filers, the deduction starts to phase out at $63,000 and disappears at $73,000. For married couples filing jointly, the phase-out is from $101,000 to $121,000.

Your next move depends on your goals and situation. If you’re primarily concerned with reducing your current tax bill and you’re likely to be in a lower tax bracket in retirement, as most people will, then you should funnel more money into your 401(k) rather than funding your IRA.

If, however, you expect to be in the same or higher bracket in retirement, or if you want more flexibility to control your tax bill in your later years, consider contributing to a Roth IRA in addition to your 401(k). Roths don’t offer an up-front deduction, but withdrawals in retirement are tax free. Also, unlike 401(k)s and traditional IRAs, there are no minimum required withdrawals in retirement.

There are income limits on the ability to contribute to a Roth IRA. For single people, the ability to contribute phases out between modified adjusted gross incomes of $120,000 to $135,000 in 2018. For married couples filing jointly, the phase-out is between $189,000 and $199,000.

Q&A: The idea here is not to cheat public servants

Dear Liz: Thanks for your column about Social Security claiming strategies. Here’s a further complication you didn’t address. If the surviving spouse is a teacher in many states, access to survivor’s Social Security benefits is further restricted (if not entirely blocked) by a misogynistic, anti-teacher ruling dubbed the windfall elimination provision, which perhaps was a backlash against the women’s liberation movement of the 1970s and 1980s.

Any clarification on the windfall elimination provision’s inconsistent application and its impact on my widow’s fixed income will be greatly appreciated.

Answer: The explanation is actually a lot more prosaic.

The windfall elimination provision and a related measure, the government pension offset, were not designed to rob public servants of benefits other people get. Instead, the provisions were meant to keep those who get government pensions from getting significantly bigger benefits than people in the private sector.

The provision that would reduce and possibly eliminate your spouse’s survivor benefit is actually the government pension offset. The offset, like the windfall elimination provision, applies to people who get pensions from jobs that didn’t pay into the Social Security system. (Some school systems, as well as other state and local government employers, have opted out of Social Security and provide their own pensions instead.)

If both you and your spouse had only Social Security and no government pensions, one of your two Social Security checks would stop at your death. After that, your spouse would get one check — the larger of the two checks the household received — as a survivor benefit.

If the government pension offset didn’t exist, your widow c​ould receive two checks: a survivor benefit equal to your Social Security benefit, plus her pension. She potentially would be getting a lot more from Social Security than those who paid into Social Security their entire working lives.

The windfall elimination provision, meanwhile, applies to people who have government pensions but also worked in jobs that paid into Social Security.

When people don’t pay into the system for several years because they have jobs with government pensions instead, their annual Social Security earnings for those years are reported as zero. Because Social Security is based on ​workers’ 35 highest-earning years, those zeros make it look like they have lower lifetime earnings than they actually did.

That’s a problem because the Social Security system is progressive, replacing more income for lower-earning workers than for higher-earning ones. Without adjustments, people with pensions would look like lower earners than they actually were. They would wind up with bigger Social Security checks than someone who had the same income in a private-sector job that paid in a lot more in Social Security taxes.

These provisions are complicated and hard to explain, which is part of the reason some people jump to the conclusion they’re being denied something others are getting. In reality, the provisions were meant to make the system more fair.

Q&A: Don’t run out of money in retirement: Here’s how much to use per year, and why

Dear Liz: I am confused about “safe withdrawal rates” from retirement accounts. I’ve read that withdrawing 4% of savings each year is the gold standard that financial planners utilize to ensure that life savings are preserved in retirement.

However, if the Standard & Poor’s 500 index returns on average 8% a year, and if the life savings are locked down in a mutual fund that is indexed to the S&P 500, then shouldn’t the annual withdrawal amount, to preserve those savings, be 8%? Limiting my withdrawals to 4% means my retirement would be pushed several years down the road. Can you clarify?

Answer: It’s good you asked this question before you retired, rather than afterward when it might have been too late.

You’re right that on average, the S&P 500 has returned at least 8% annualized returns in every rolling 30-year period since 1926. (“Rolling” means each 30-year period starting in 1926, then 1927, then 1928, and so on.)

But the market doesn’t return 8% each and every year. Some years are up a lot more. And some are down — way down. In 2008, for example, the S&P 500 lost about 37% of its value in a single year.

Such big downturns are especially risky for retirees, because retirees are drawing money from a shrinking pool of assets. The money they withdraw doesn’t have the chance to benefit from the inevitable rebound when stock prices recover. Bad markets, particularly at the beginning of someone’s retirement, can dramatically increase the odds of running out of money.

Inflation also can vary, as can returns on cash and bonds. All these factors play a role in how long a pot of money can be expected to last. The “4% rule” resulted from research by financial planner William Bengen, who in the 1990s examined historical returns from 1926 to 1976. Bengen found there was no period when an initial 4% withdrawal, adjusted each year afterward for inflation, would have exhausted a diversified investment portfolio of stocks and bonds in less than 33 years.

Some subsequent research has suggested a 3% initial withdrawal rate might be better, especially for early retirees or those with more conservative, bond-heavy portfolios.

Free online calculators can give you some idea of whether you’re on track to retire. A good one to check out is T. Rowe Price’s retirement income calculator. But you’d be smart to run your findings past a fee-only financial planner as well. The decisions you make in the years around retirement are often irreversible, and what you don’t know can hurt you.

Q&A: What’s better, collecting Social Security early or blowing through retirement savings?

Dear Liz: I am married and six months away from my full retirement age, which is 66. I have not filed yet. My wife started collecting Social Security at 62 but does not get very much. We are both in excellent health and have longevity in the genes. We don’t own a home. I have around $960,000 in diversified investments. I take out around $7,000 to $8,000 a month to meet my monthly expenses. Fortunately, the markets have been good, helping my portfolio, but I am not counting on that to continue at the same pace.

Doesn’t it make more sense to be taking less money out each month by starting Social Security now? I know I would receive less money than waiting until 66 or later, but between my check and the spousal benefit my wife could get, I would reduce my annual living expense withdrawals from my account by close to 50%. This would give my portfolio more opportunity to grow, since I will not be taking out so much every month.

I wish I could cut my expenses or could earn more income but cannot at this point. I am shooting for not taking more than 5% a year out of the portfolio going forward.

Answer: You’re right that something needs to change, because your withdrawal rate is way too high.

You’re currently consuming between 8.75% and 10% of your portfolio annually. Financial planners traditionally considered 4% to be a sustainable withdrawal rate. Any higher and you run significant risks of running out of money.

Some financial planning researchers now think the optimum withdrawal rate should be closer to 3%, especially for people like you with longevity in their genes. Chances are good that one or both of you will make it into your 90s, which means your portfolio may need to last three decades or more.

So even if you start Social Security now, you’ll need to reduce your expenses or earn more money to get your withdrawals down to a sustainable level.

Generally, it’s a good idea for the higher earner in a couple to put off filing as long as possible. The surviving spouse will have to get by on one Social Security check, instead of two, and it will be the larger of the two checks the couple received. Maximizing that check is important as longevity insurance, since the longer people live, the more likely they are to run through their other assets. Your check will grow 8% each year you can delay past 66, and that’s a guaranteed return you can’t match anywhere else. In many cases, financial planners will suggest tapping retirement funds if necessary to delay filing.

But every situation is unique. Your smartest move would be to consult a fee-only financial planner who can review your individual situation and give you personalized advice.