Ask Liz Weston

Get smart with your money

Liz Weston

Get second opinion before buying cash-value insurance

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Dear Liz: I think you missed one of the possibilities when a reader wrote to you about a pitch he received from an insurance salesman. The salesman wanted the reader to stop funding his 401(k) and instead invest in a contract that would guarantee his principal but cap his returns in any given year. You thought the salesman was pitching an equity indexed annuity, but it’s possible he was promoting an indexed universal life policy, which would offer the same guarantees of principal and offer tax-free loans.

Answer: You may be correct — in which case the product being pitched is just as unlikely to be a good fit for the 61-year-old reader as an equity indexed annuity.

Cash-value life insurance policies typically have high expenses and make sense only when there’s a permanent need for life insurance. If the reader doesn’t have people who are financially dependent on him, he may not need life insurance at all.

Furthermore, the “lapse rate” for cash-value life insurance policies tends to be high, which means many people stop paying the costly premiums long before they accumulate any cash value that can be tapped.

Before you invest in any annuity or life insurance product, get an independent second opinion. One way is to run the product past a fee-only financial planner, who should be able to analyze the product and advise you of options that may be a better fit for your situation. If you just want a detailed analysis of the policy itself, you can pay $100 to EvaluateLifeInsurance.org, which is run by former state insurance commissioner James Hunt.

Settling co-signed student loan debt

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Dear Liz: My daughter co-signed a student loan for a friend who failed to pay the debt. Now my daughter cannot refinance her home because this loan appears on her otherwise very good credit reports. She has been getting calls from a collection agency.

I called the agency to discuss what it would cost to get her released from all liability regarding this loan, and they gave me an offer of $13,000 to satisfy the debt, which is now $35,000. I countered with $9,000, since the original loan was just $15,000, but they refused. My daughter is unhappy about paying anything, since her ex-friend is a gainfully employed attorney. Is it good business to pay what the collection agency is asking, or should I continue to negotiate?

Answer: That sounds like a pretty good offer, said financial aid expert Mark Kantrowitz, publisher of the FinAid and Fastweb websites.

“Lenders almost never settle for less than the outstanding principal balance of a defaulted student loan, so that may be the best she can get,” Kantrowitz said. “It may be the case that they are offering her a low settlement amount to release her from her obligation and then will go after her former friend for the remaining debt. When there are two borrowers on the hook, one borrower reaching a settlement does not cancel the debt. It merely releases that borrower from her obligation.”

Your daughter should have the settlement offer reviewed by an attorney, Kantrowitz said. The attorney should verify that the collection agency has the authority to settle the debt, and any agreement should list all of the loans involved.

“I’ve seen cases where a borrower thought she was getting a settlement of all the loans,” Kantrowitz said, “but the settlement was just for some of the loans.”

Ideally, the settlement agreement would require the lender to stop reporting the default and delinquencies to the credit bureaus, which would remove the stain from her credit reports. Not all lenders will agree to such a condition, Kantrowitz said, but removal would be better for her credit than simply having the debt reported as “satisfied.”

Also, the agreement should require that the lender provide a “paid in full” statement to your daughter as proof her debt has been settled, Kantrowitz said.

“She should keep this statement forever,” Kantrowitz said, “as defaulted loans have a tendency to resurrect themselves from time to time, [such as when] a bank reloads their database from old backup tapes [or] someone reviewing old records discovers the original promissory note.”

An attorney also could advise your daughter about taking further steps, such as suing the former friend for repayment or reporting the issue to the state bar, which has standards of professional conduct that may be violated by an unpaid debt.

Skip a payment, trash your scores

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Dear Liz: We are trying to negotiate our second mortgage and have not paid it since June. Will this affect my wanting to purchase an auto?

Answer: It may not affect your desire to purchase a car, but it’s likely to affect the actual transaction if you’re not able to pay cash.

Failing to pay a credit obligation can devastate your credit scores, the three-digit numbers lenders use to gauge your creditworthiness. The worse your scores, the less likely you are to find a lender willing to do business with you. Even if you can secure a loan, it’s likely to come with a scandalously high interest rate.

The one money book you must read this year

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pound-foolish-170x281You may not agree with everything Helaine Olen writes in her new book, “Pound Foolish: Exposing the Dark Side of the Personal Finance Industry.” That’s particularly true if you’re an uncritical fan of one of the personal finance gurus she skewers so effectively.

For the sake of your wallet, you should read the book anyway. She’s a friend of mine, so I’m biased, but the following sources are not:

  • The New York Times, which called “Pound Foolish” one of the rare “realistic and readable” books about personal finance.
  • The Washington Post’s Michelle Singletary, who says the book “provides a cautionary tale that you need to read.”
  • The Economist says it’s an “excellent book, a contemptuous exposé of the American personal-finance industry.”

Helaine articulates what too many of us in the financial media took too long to figure out: that your money problems may not be entirely your own fault. Most Americans have been fighting economic headwinds for decades. Incomes have stagnated or even fallen while costs for education and health care spiral relentless upward. People can work for years to build up economic security only to have it wiped out when they lose their jobs, get divorced, suffer disability or illness or simply retire at the wrong time.

Here’s how the New York Times reviewer summarized it:

What most advice fails to factor in — and what we often choose to overlook ourselves — are the costly realities of things like job loss, protracted unemployment, medical bankruptcy and high-interest debt. Even when we do save, plummeting interest rates, falling home prices and other economic events imperil our best efforts.

Yet some of the best-known financial advice-givers make millions pretending that anyone can save his or her way to financial security. Meanwhile, legions of commissioned salespeople posing as advisors fleece people out of billions more, selling overpriced insurance and investment products to people desperate for financial guarantees.

I’m not saying, as some commentators have, that saving is pointless or impossible on modest incomes. That just plays into the hands of those who contend that financial issues are entirely a matter of personal responsibility, since they (and I) can provide plenty of examples of people who have saved prodigious amounts on small incomes, even in high-cost areas.

What the “personal responsibility” folks are missing is how easy it is to lose those savings in the 21st century, especially if you weren’t born to the right parents or are otherwise are on the wrong side of the growing wealth and income disparities.

Simply put, there are limits to how much personal finance advice or “financial literacy” efforts can help people who don’t make much money, don’t have a lot of education or aren’t just plain lucky in the lottery of life.

Personal responsibility alone isn’t enough; we need some corporate responsibility and a government capable of enforcing regulations that ensure fair play. We need affordable, available health insurance to protect people from catastrophic medical bills; we need a strong Social Security system to prevent us from ending our days in poverty. Our kids need affordable educations so more of them have a shot at staying in the middle class without drowning themselves in student loan debt.

In short, we need to stop acting like we’re in this alone. We should continue contributing to our 401(k)s, but we—and those who advise us—shouldn’t pretend that’s all we need to do to ensure our financial futures.

Insurance better than 401(k)?

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Dear Liz: Recently, someone from an insurance company proposed that I stop investing through my 401(k) at work and instead invest in his insurance company contract with after-tax dollars. He claims the funds would be guaranteed so that I would never lose principal, although there would be a cap on how much I could make in any given year. His claim is that it is better to forgo the tax deduction I would get from my 401(k) contributions so that I can take the money out of this contract tax-free in 20 or 30 years. I think I am too old for this program (I am 61 now) but I thought it might be appropriate for my daughter when she enters the workforce in a few years.

Answer: You may have been pitched an equity-indexed annuity. These are extremely complex investments that should not be purchased from someone who misrepresents how they work and who encourages you to forgo better methods of saving for retirement.

Withdrawals from annuities are not tax-free. You would not have to pay income tax on the portion of the withdrawal that represents your initial contributions, but any gain would be taxable at regular income tax rates.

Furthermore, most people fall into a lower tax bracket in retirement. That makes the tax break offered by 401(k) contributions especially valuable, because you’re getting the deduction when your tax rate is higher and paying the tax when your rate is lower.

The Financial Industry Regulatory Authority, which regulates securities firms, has warned that most investors consider equity-indexed annuities and other annuity products “only after they make the maximum contribution to their 401(k) and other before-tax retirement plans.”

Even then, you probably have better ways to save. Contributions to a Roth IRA would not be tax-deductible, but withdrawals in retirement would be tax-free. If you’re able to save still more, you could contribute to a regular, taxable brokerage account and hold your investments at least one year to qualify for long-term capital gains rates, which are lower than regular income tax rates.

The other possibility is that the insurance salesman was pitching a life insurance policy that would allow you to take out a tax-free loan. Although life insurance is sometimes pitched as a retirement savings vehicle, it’s an expensive way to go. In general, you should buy life insurance only if you need life insurance. To help ensure a policy is suitable for your situation, you should take it to a fee-only financial planner—one who does not make commissions from selling investments–for review.

In any case, you don’t want to do business with someone suggests you stop funding your workplace retirement plan, and you certainly don’t want to refer him to family members. What you should do instead is pick up the phone and report him to your state insurance department.