Ask Liz Weston

Get smart with your money

Q&A

Q&A: Pension annuity beats lump sum

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Dear Liz: I am 63, recently retired and have a choice. I can take a lump sum from my pension at age 65 or a monthly annuity. I am strongly leaning toward the lump sum. I know the pitfalls (I won’t be an aggressive investor, I don’t gamble, I won’t loan to family or friends, etc). My reasoning is that if my spouse and I both die before our early 80s, “they win.”

I do have relatives who live a long time, however. I am financially very careful and believe interest rates in five years will be several points higher and I can invest the lump sum conservatively and get a 5% to 7% return, and that will work for me.

Finally, I could take the monthly annuity now with no survivor benefit and at the same time buy term life insurance to cover my wife if I go. Am I missing anything significant in my favoring the lump sum?

Answer: Yes. Quite a bit.

Calculating break-even points can be an interesting math exercise, but you’re making assumptions about inflation rates and market returns, as well as life expectancies, that you can’t actually know in advance. A better approach might be to consider what could possibly go wrong. The answer: a lot.

Technically, you might do better investing the money than collecting the annuity, but there are so many ways you could wind up losing. You could pick the wrong investments, or the markets could turn south for an extended period. You could be defrauded or become the victim of an unethical advisor.

(Sure, you’ve got all your marbles now, but who says you’ll keep them? Even the smartest people can get fleeced, and any cognitive decline over the years could make you a sitting duck.)

The fact that you have longevity in your family is another big factor in favor of taking the annuity, because you can’t outlive the money. That should be a concern, in any case, because according to the Society of Actuaries there’s a 72% chance that one member of a couple will live to age 85 and a 45% chance that one will live to age 90.

If your spouse is a woman and not several years older than you, she’s likely to outlive you. Does she want to inherit the responsibility of managing this money?
Speaking of your spouse, get an independent, fee-only advisor’s opinion before you consider waiving the survivor’s benefit on any annuity.

A term life insurance policy may not last as long as you need it to, and will be expensive at your age. It will be vastly more expensive if you try to renew it down the road.
If you don’t or can’t renew it, your spouse could face a drastic drop in income at your death as one of your two Social Security checks goes away and the pension income stops. Surely, your partner deserves better than that.

Q&A: How much should you pay your financial advisor?

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Dear Liz: With my advisor’s blessing, I took one of my brokerage accounts and converted it from stocks to mutual funds that charge an aggregate fee of 0.26%. Not too bad, but my advisor insists that he still must charge his standard 1% fee on top. I know of other people whose advisors dropped their fees to 0.5% or even less in similar situations. What is a fair fee in this case, and is my only option to find another advisor?

Answer: For context, robo-advisors — services that invest and rebalance portfolios according to computer algorithms — typically have an “all in” cost of about 0.5%. That includes the advisory fee plus the cost of the underlying investments. Some robo-services offer access to human advisors for investment and financial planning questions, while others do not.

If you’re paying much more than 0.5% “all in,” you should be getting more in the way of investment and financial planning services. Is your advisor available to help with your questions about taxes, insurance, college savings, long-term care, retirement and estate planning? Did he create, and is he regularly updating, a comprehensive financial plan for you?

If you’re getting all that, then a 1% fee may be fair, especially if yours is a relatively small portfolio. (A survey of 1,000 financial planners by trade publication Inside Information last year found 1% was the median annual advisory charge for portfolios of $1 million or less, while the median fee for portfolios in the $5 million to $10 million range was 0.5%.)

If all you’re getting for your 1% is investment management, though, you might consider looking elsewhere if your advisor isn’t willing to adjust his fee.

Q&A: Finding a place for Mom

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Dear Liz: Our mom is a recent widow, living in Seattle in a house that’s over 100 years old and worth about $1.2 million. She’s anxious about things going wrong, such as a recent sewer system repair to the tune of $10,000. She wants to have less uncertainty about her finances in general, live in a space that could support her aging in place and stay near her support system in that neighborhood.

All her children are 100% fine with her selling the house. We love the house, but we love our mother 1,000 times more. She and my siblings have talked about renting out the house and building a mother-in-law apartment on land near a home my sister owns, or remodeling a home my brother owns. I have suggested just selling and then buying a ready-to-move-in condo that would suit my Mom and her mobility.

I know she will be penalized when or if she sells the house, though. If she sold the house and wound up worse off, I’d never forgive myself. How can we find out more about her options?

Answer: Good news — your mom isn’t likely to owe any taxes on the sale of her home.

She lives in a community property state, so her entire house got a new value for tax purposes when your father died. If the home was worth $1.2 million when he died, that would be the value subtracted from the sale price to determine if there was any taxable profit. (In non-community property states, only his half would have gotten this “step up” in basis.)

Any increase in the home’s value since he died would probably be offset by the $250,000 home profit exemption available to homeowners who have lived in their primary residences for at least two of the past five years.

In addition to the options your family has already discussed, your mother also may want to explore “continuing care” communities that would allow her to live independently while providing assisted living or nursing home care as she ages.

These communities aren’t cheap. They tend to have hefty, up-front fees of $100,000 to $1 million in addition to monthly fees of $3,000 to $5,000 that may increase as her needs change, according to AARP. For those who can afford them, though, continuing care communities offer a potentially attractive way to provide future care without requiring a late-in-life move.

She’ll have the most options if she moves to a community while she’s still relatively healthy. AARP has more information about how to evaluate and choose a continuing care retirement community.

Q&A: Why it’s important to pay bills on time

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Dear Liz: I recently checked one of those free credit score sites and saw three delinquent department store accounts from over a year ago. I was 30 days late but paid all three accounts in full last year. What can I do to remove that from my credit report?

Answer: You can ask the store credit card issuers, in writing, if they’d be willing to remove the late payments from your credit reports. If this was a one-time mistake, they may grant your request.

If they don’t, you’re pretty much out of luck. Accurate, negative information can remain on your credit reports for seven years. The effect on your credit scores will wane over time, but your scores may not be fully restored for as long as three years. This is why it’s so important to make sure all credit accounts are paid on time, since even a one-time lapse can have serious repercussions.

Q&A: What to consider when you’re deciding whether to sell and move for better schools

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Dear Liz: I’m 47, married, with one child in private elementary school because the public school option for our neighborhood is not good. We earn a combined $260,000 per year. (We know we’re fortunate, as we come from lower-income circumstances). I’ve eliminated all of my credit card debt and owe only mortgage debt ($168,000 plus $30,000 on a line of credit used for remodeling). Our home is worth about $350,000 and the scheduled mortgage payoff is about 25 years from now.

We’ve thought of moving for a bigger, better house and especially better school options as our child grows through middle and high school. However, we’ve begun to think that staying put is better, since a new house will be much more expensive and a new 30-year mortgage would mean we’d still have a mortgage payment into our 70s. I saw my dad struggle in retirement because he still had a mortgage to pay on a fixed income; I don’t want that.

If we stay put and are aggressive, we can pay off the current house much sooner than 25 years. Any advantage of moving to a place with good public school options at best pencils out the same financially as private school because of increased mortgage costs. But I see peers and family members moving around, taking on mortgage debt that they won’t pay off before they retire. Are we making the right financial decision in staying put?

Answer: You’re not wrong to want to avoid a mortgage in retirement — or the considerable costs of moving. Each move can eat up 10% or more of your current home’s value, once you account for real estate agent commissions and other selling costs, plus moving expenses. Minimizing the number of moves you make in a lifetime can save you a considerable amount of money.

That said, paying the premium for a home in a better school district may pay off in greater appreciation and perhaps less risk of loss during a downturn.

Because the other financial costs of moving versus staying put are roughly equal, perhaps you should think about your future. Do you want to move to another community when you retire, or do you plan to stay put?

If you’ll remain, is your current home a good option for your later years, or can it be remodeled to help you age in place? The best layout would be to have the main living areas, including a bedroom and a full bath, on one level. Ideally, there also would be at least one entry with no steps, hallways and doorways at least 36 inches wide and enough space in the main rooms for a wheelchair to turn around — generally a 5-foot-by-5-foot clear space, according to the National Assn. of Home Builders.

Some homes can’t be made age-friendly. If that’s the case, and you don’t want to move to another area when you retire, making the move to a more appropriate house now could make sense.

In any case, thinking about the next phase of your life may bring more clarity to the “stay vs. move” decision and help you arrange your finances accordingly.

Q&A: Rebalancing your portfolio can trigger tax bills

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Dear Liz: Is there a tax aspect to rebalancing your portfolio? You’ve mentioned the importance of rebalancing regularly to reduce risk.

Answer: Rebalancing is basically the process of adjusting your portfolio back to a target asset allocation, or mix of stocks, bonds and cash. When stocks have been climbing, you can wind up with too high an exposure to the stock market, which means any downturn can hurt you disproportionately.

There definitely can be tax consequences to rebalancing, depending on whether the money is invested in retirement plans.

Rebalancing inside an IRA, 401(k) or other tax-deferred account won’t trigger a tax bill. Rebalancing in a regular account could. Investments held longer than a year may qualify for lower capital gains tax rates, but those held less than a year are typically taxed at regular income tax rates when they’re sold.

Tax experts often recommend selling some losers to offset winners’ gains, and “robo advisor” services that invest according to computer algorithms may offer automated “tax loss harvesting” to reduce tax bills.