Ask Liz Weston

Get smart with your money

Liz Weston

Save or pay debt? Do both

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Dear Liz: I am a 67-year-old college instructor who plans to teach full time for at least eight more years. Last year I began collecting spousal benefits based on my ex-husband’s Social Security earnings record. Those benefits give me an extra $1,250 each month above my regular income. I have been using the money to pay down a home equity line of credit that I have on my condo. The credit line now has a balance of $29,000. I have about $200,000 in mutual funds and should have a small pension when I retire. (I went into teaching only a few years ago.) Would it be better for me to split the extra monthly $1,250 into investments as well as paying off my line of credit? The idea of having no loan on my condo appeals to me, but I wonder if I should try to invest in stocks and bonds instead.

Answer: Paying down debt is important, but opportunities to save in tax-advantaged retirement plans are typically more important. Fortunately, you probably have enough money to do both.

First investigate whether your college offers a 403(b) or other retirement program that offers a match. If it does, you should be contributing at least enough to that plan to get the full match.

Your next step is to explore an IRA. Since you’re covered by at least one retirement plan at work (your pension), you would be able to deduct a full IRA contribution only if your modified adjusted gross income as a single taxpayer is $59,000 or less in 2013. The ability to deduct a contribution phases out completely at $69,000.

If you can’t deduct your contribution, consider putting the money into a Roth IRA instead. Roth contributions aren’t deductible, but withdrawals in retirement are tax free. Having a bucket of tax-free money to draw upon in retirement can help you better manage your tax bill, which is why some investors opt to contribute to Roths even when they could get a deduction elsewhere.

People 50 and older can contribute up to $6,500 this year directly to a Roth if their income is under certain limits. (For singles, the limit for a full contribution is a modified adjusted gross income of $112,000 or less.) If your income is over the limit, you can contribute to a traditional IRA and then immediately convert the money into a Roth IRA, since there’s no income limit on conversions. (This is known as a “back door” Roth contribution.)

Since you’re so close to retirement, you don’t want to overdose on stocks, but you still need a significant amount of stock market exposure so that your money has a chance to offset future inflation. You might consider a balanced fund that invests 60% in stocks, 40% in bonds.

Once you’ve taken advantage of your retirement savings options, you can direct the rest of your Social Security benefit to paying off your home equity line. These credit lines typically have low but variable rates. Higher interest rates are likely in our future, so paying this line down over time is a prudent move.

Estate taxes no longer a worry for most people

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Dear Liz: My father passed away two years ago and my mother recently died as well. I will be getting about $50,000 from the sale of their house. Everyone tells me the tax on this will be very high, so I need advice about how not to give my parents’ money to the government. Their grandchildren should be able to see a legacy of their grandparents.

Answer: You need to stop listening to “everyone,” since these people clearly don’t know what they’re talking about.

You have to be pretty rich to worry about estate taxes these days. The money you inherit wouldn’t be subject to federal estate taxes unless your parents’ estates exceeded the federal exemption limit (which is currently more than $5 million per person). Some states have lower limits and a few have “inheritance taxes,” which base the tax rate on who is inheriting (spouses are typically exempt, and lineal descendants such as children pay a lower rate than others).

The vast majority of inheritors, however, won’t face any of these taxes. You should check with a tax pro, but chances are good your inheritance won’t incur a tax bill and you’ll be able to pass the entire amount along to your children without taxes as well if you wish.

Monday’s need-to-know money news

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Little Girl with Crown of EarsHow to survive your child’s summer vacation without emptying your wallet, protecting your tuition investments, and how to ensure your semester abroad doesn’t lead to financial disaster.

Six Ways to Save Money on Summer Childcare
Keeping your child busy this summer doesn’t have to mean breaking the bank.

Why a Good Student Checking Account Matters

Student checking accounts are a perfect way to teach financial responsibility.

Kids and Money: Tuition is an Insurable Investment

Tuition refund insurance can provide peace of mind.

Plan For Financial Independence, Not Retirement
Financial independence can mean working when you want; not because you have to.

4 Credit Card Tips for College Students Headed Overseas

How to avoid a financial mess when studying abroad.

Marketplace launches “Family Feud”

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RelationshipActually, the new feature from public radio’s Marketplace Money is called “Financial Feud,” but it deals with some family arguments about money that may sound more than a little familiar. Such as:

  • Should I quit work to stay home with the baby when day care eats up most of my pay?
  • My husband is going nuts with airline credit cards. He says the rewards are worth the cost. Is he right?
  • Where do you draw the line between energy savings and comfort? (Ah, the battle of the thermostat…)
  • What’s the best way for roommates to split food costs?
  • And then there’s the $10,000 bike…

Check out these very real disputes submitted by listeners, see what the experts have said and weigh in what you think.

Catch me on CNBC’s Closing Bell today

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DWYD cover2013I’m scheduled to talk about mid-year financial moves you should be making now. It’ll be a short appearance somewhere around 4:20 p.m. Eastern.

Also, this weekend, listen to Marketplace Money where I’ll be weighing in on a couple’s argument about whether she should quit her job to stay home with their child. Everybody’s conflicted on this one, and for good reason.

Finally, in case you missed it, a couple of columns about young people’s finances:

Why young people hate credit cards

The Great Recession made many younger consumers afraid to borrow money, but alternatives like debit cards have their own drawbacks.

Student loan debt crushing couple

As part of MSN Money’s Life Coach series, I offer alternatives for a young couple trapped by student loan bills.

Student loan rates: facts amid the fictions

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Paid education. Graduate cap on bank notesStudent loan rates aren’t about to double, despite the headlines.

Only rates for newly-issued, subsidized federal student loans are set to rise July 1 from 3.4% to 6.8% because Congress couldn’t get its act together to prevent the increase.

Loans that have already been made won’t be affected. Neither will there be an impact on unsubsidized federal student loans, since those already carried a 6.8% rate, or on PLUS loans for graduate students and parents, which have a 7.9% rate.

Subsidized loans traditionally got lower rates because the borrowers have demonstrated financial need. But subsidized loans also charge no interest:

  • while the student is still in school at least half time
  • for the first six months after the student leaves school and
  • during an approved postponement of loan payments.

Those are powerful advantages not available on unsubsidized loans, which is what you get when you can’t demonstrate financial need.

College expert Lynn O’Shaughnessy points out in her MoneyWatch column that the doubling of subsidized loan rates actually won’t have an outsized impact:

The hike will mean that a borrower will spend less than $7 a month repaying that extra interest, according to Mark Kantrowitz, the publisher of Edvisors Network and a national financial-aid expert. Keeping the subsidized rate at 3.4 percent would cost the government $41 billion over 10 years, which is a high price to pay to save borrowers a few dollars a month.

Kantrowitz has said it’s unlikely that higher interest rates would dissuade many from attending college, and he would rather see the money go toward increasing Pell grants for the neediest students, which would do a lot more to encourage them to get a degree. Here’s what he had to say in a New York Times op-ed piece co-authored with O’Shaughnessy:

But the partisan posturing is a distraction from far more pressing issues that face students and parents who must borrow to cover their college costs. What’s lost is how Congress, in numerous ways, has been hurting the most vulnerable college students and dithering on the crisis of college affordability….Congress has starved the Pell grant program, an educational lifeline for low-income families.

He goes on to question why most student loan rates are so much higher than the government’s cost, something that’s turned education debt into a profit center for Uncle Sam. Congress also hasn’t done anything about the suffocating student loan debt many graduates have already taken on or the continuing (if somewhat moderated) increase in education costs. Private student loans remain especially problematic, since they lack the consumer protections of federal student loans and many lenders have been unwilling to work with borrowers to create affordable repayment plans. I’ve argued that we should give bankruptcy judges the power to modify private student loan terms as a way of forcing lenders to play ball.

Nobody wants to pay more interest, but there are bigger problems with the way we pay for higher education than a hike in the subsidized student loan rate.