Ask Liz Weston

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Liz Weston

Q&A: Don’t do this with your retirement funds — unless you want to pay tax

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Dear Liz: I recently switched jobs and realized that I have multiple 401(k) accounts from prior employers over the years that need to be consolidated. When I reached out to my current employer’s 401(k) administrator to understand the rollover process, they said I would actually need to have a paper check mailed to me for each prior employer and then arrange to mail the checks to them. Liz, we are talking about four checks totaling a very substantial amount of money! They said there is “no other way” to process the rollovers. I cannot understand why we are still dealing with such an archaic process in this day and age. Should I be worried or should I just go ahead and take care of this now since I don’t seem to have much say in the process?

Answer: You should definitely be worried, and you also shouldn’t assume that your employer’s 401(k) administrator understands the options at other companies. Getting a check in the mail from an old plan is not only unsafe but triggers a 20% withholding requirement.

If you want to avoid taxes and penalties on the missing 20%, you’d have to come up with that money out of your own pocket. (If you didn’t deposit the check with the new plan or in an IRA, you’d owe taxes and potentially penalties on all of the money.)

When you contact the old plan’s administrators, ask if they can do a “direct rollover” to your new 401(k) account. Often, the transfer can be made electronically.

Even if the old plan uses a paper check and the U.S. mail to deliver the funds, you can avoid the 20% withholding requirement if the check is made out to your new account rather than to you.

Make the most of new rules for charitable giving

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Most people no longer get a tax deduction when they donate to charity. That shouldn’t keep you from making donations, but you may want to change your approach.

Typically, only taxpayers who itemize deductions can write off charitable contributions. The vast majority of taxpayers instead take the standard deduction, which was nearly doubled by the Tax Cuts and Jobs Act of 2017. (Temporary provisions in pandemic relief legislation allowed taxpayers to deduct $300 of their donations in 2020 and 2021 without itemizing, but those provisions have expired.)

It has never made sense to donate solely to get a deduction. If you’re in the 22% federal tax bracket, for example, you save only 22 cents in taxes for each dollar you give away. If you’re charitably minded, however, there may still be ways to get a tax break for your generosity with some planning, or you could reconsider how you give money away. In my latest for the Associated Press, learn new rules for charitable giving.

This week’s money news

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This week’s top story: Smart Money podcast on end of credit card rewards, and luxury credit cards. In other news: December mortgage rates, how high-interest ‘rent-a-bank’ loans sidestep state rate caps, and lifetime income.

Smart Money Podcast: The End of Credit Card Rewards, and When to Cancel Luxury Credit Cards
This week’s episode starts with a discussion about the potential end of credit card rewards.

December Mortgage Rates May Seek Calm After Turbulent Year
Interest rates on fixed-rate mortgages could stabilize or even drift lower in December.

How High-Interest ‘Rent-a-Bank’ Loans Sidestep State Rate Caps
Rent-a-bank loans are online loans that may charge triple-digit APRs in states that cap interest rates on small loans.

Save for ‘Retirement’? Generate Lifetime Income Instead
Money News & Moves: Also, Google pays for tracking us, and crypto isn’t broken.

Q&A: Claiming divorced spousal benefits

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Dear Liz: My son is 59, and his ex-wife died approximately 12 years ago. She was a nurse and paid more into Social Security than he has. Is he entitled to her Social Security benefits as indicated in your article? How does he file and get more information? Must he wait until he is 62?

Answer: If their marriage lasted at least 10 years, he could begin divorced survivor benefits as early as age 60, or age 50 if he is disabled. (He can remarry at age 60 or later and still receive survivor benefits.)

Benefits are reduced if he applies before his full retirement age, which will be 67. Also, starting before full retirement age means the benefits are subject to the earnings test that withholds $1 in benefits for every $2 earned over a certain amount, which in 2023 will be $21,240.

If he earns too much to make starting early worthwhile, he could apply for divorced survivor benefits at age 67, when the earnings test goes away. His own retirement benefit could continue to grow until age 70, and he could switch at that point if his own benefit is larger.

But he’d be smart to consult a financial planner or use a Social Security strategy site, such as Maximize My Social Security or Social Security Solutions, to craft the best approach.

He can call Social Security’s toll free number at (800) 772-1213 for more information.

Q&A: Mom gave them her house before she died. Why that’s bad

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Dear Liz: My mother gave her house to my brother and me in 2011 by quitclaim deed. My brother lived in the house with her until she passed in 2018, and he continues to live there. He wants to buy my half of the home, and I am wondering what my taxes may be because I am not purchasing another home with my proceeds. Since this was a gift, do these things apply? The home is valued at $500,000 so my half is worth $250,000.

Answer: Your tax bill will be based on what your mother paid for the home originally, plus any qualifying home improvements she made over the years. That is what’s known as the home’s tax basis, and it will be subtracted from the sale proceeds to determine your potentially taxable capital gain.

Let’s say your mother originally paid $100,000 for the house and remodeled the kitchen for $50,000, for a total basis of $150,000. When she gave you and your brother the house, you each received half of that basis, or $75,000. If your brother pays you $250,000, you would subtract $75,000 from those proceeds for a capital gain of $175,000.

The federal tax rate on capital gains ranges from 0% to 20% based on income, but most people pay 15%. If your state and city assess capital gains or other taxes, you’d owe those as well.

You don’t qualify for the home sale exclusion that allows many home sellers to avoid taxation on home sale profits up to $250,000. To get the exclusion, you must own and live in the home at least two of the previous five years.

It doesn’t matter that you don’t plan to buy another home; the tax law that allowed people to roll home sale profits into another home went away decades ago.

Your tax bill might have been substantially reduced if your mother had bequeathed the home to you and your brother, rather than giving it before her death. If she’d left it to you in a will or living trust, at her death the tax basis would have been “stepped up” to the home’s current fair market value.

If the home was worth $450,000 at her death, for example, you and your brother would have a tax basis of $225,000 each. If he paid you $250,000, your taxable gain would have been just $25,000.

You might be able to spread out the tax bill if your brother is willing to pay you over time rather than buy you out all at once, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

That would be one of several issues you should discuss with a tax pro before proceeding. A big capital gain can affect other aspects of your taxes and may require you to make estimated quarterly payments to avoid penalties for underpayment. A tax pro can advise you about what to expect and how to pay what you owe.

Holiday survival tips from 5 financial pros

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For Ryan Decker, surviving the holiday shopping season is all about planning ahead. In fact, if he sees a gift for one of his two young sons in March, he’ll go ahead and buy it, instead of rushing through his shopping list in December.

“It very much eases the burden,” he says, making his December bills more manageable because he spreads holiday costs throughout the year.

Decker, a certified financial planner and director of the Center for Financial Literacy at North Central College in Naperville, Illinois, says that without that kind of advance planning, the costs this time of year can quickly overwhelm budgets. “Inflation is eating away at our purchase power, so once you throw in the holiday season, it’s a very stressful time.”

Financial educators like Decker are often busy during the holiday shopping season, sharing tips with their audiences about how to avoid debt and save money while still being festive. In Kimberly Palmer’s latest for the Associated Press, learn holiday survival tips from 5 financial pros.