Ask Liz Weston

Get smart with your money

Q&A

Q&A: Dealing with a big lottery win

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Dear Liz: My brother-in-law won a good chunk of money playing the lottery. He is waiting for the check to come any day now. He is willing to give me $2 million. The question for you is how I can maximize that amount of money short term or long term?

Answer: If your brother-in-law has any sense at all, he’ll realize he shouldn’t have promised any gifts before he assembled a team of professional advisors. And they almost certainly will have a dim view of him giving you a seven-figure sum.

Handouts that large have gift tax consequences. Anything over the annual exemption amount, which this year is $14,000 per recipient, has to be reported on a gift tax return. Amounts over $14,000 count against his lifetime exemption limit, which is $5.45 million this year. Once that limit is exceeded, he’ll owe substantial tax on any gifts.

Also, the $5.45-million limit is for gift and estate taxes combined. Any part of the exemption he uses during his lifetime for gifts won’t be available to shield his estate from estate taxes when he dies. Although, given his apparent generosity, he may not have enough left at his death to trigger an estate tax.

It’s not uncommon for those who receive large windfalls to wind up broke, especially if the amount is much larger than they’re used to handling. More than a few professional athletes and lottery winners have wound up in bankruptcy court. They spend or give away money at a clip that simply isn’t sustainable.

Which may be the road down which your brother-in-law has started. You can take advantage of your relative’s ignorance by holding him to his pledge or you can do the right thing, which is to encourage him to hire fee-only advisors — including a CPA, an estate-planning attorney and a comprehensive financial planner who’s willing to sign a fiduciary oath — to help him deal with this windfall.

Q&A: Refinancing an education loan

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Dear Liz: You were asked a question about whether it would be wise to refinance a parent PLUS loan through a private lender and you said yes because the interest rates are so much lower. Doesn’t this ignore the benefit of the IRS tax credit? I figured out that my interest rate is effectively a couple of percentage points lower because I get a $2,500 tax credit every year.

Answer: As long as you’re refinancing with another education loan, the interest is still tax deductible. The deduction is “above the line” — meaning you don’t have to itemize to get it. The student loan interest deduction can reduce your taxable income by up to $2,500 if your modified adjusted gross income is less than $80,000 for singles and $160,000 for married couples filing jointly. The amount you can deduct is phased out at higher incomes and disappears after $90,000 for singles and $180,000 for marrieds.

If you’re not clear whether you’re refinancing into an education loan (rather than, say, a personal loan), you should ask your lender.

To clarify, it’s not always a good idea to refinance, even if you get a better rate. That’s because federal education loans have consumer protections that private lenders don’t offer. For example, you can pause your payments for up to three years if you lose your job or have another financial setback. Private lenders may offer hardship deferments, but typically those max out at 12 months.

Q&A: Tips for divvying up your retirement investments

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Dear Liz: With all the investment options offered in 401(k) plans, how as a contributor do I know where to place my money?

Answer: Too many investment options can confuse contributors and lower participation rates, according to a study by social psychologist Sheena Iyengar of Columbia University in cooperation with the Vanguard Center for Retirement Research. The more options, the more likely participants are to simply divide their money evenly among the choices, according to another study published in the Journal of Marketing Research. That’s a pretty random method of asset allocation and one that may not get people to their retirement goals.

As a participant, you want a low-cost, properly diversified portfolio of investments. For most people, that means a heavy weighting toward stock funds, including at least a dab of international stocks. Your human resources department or the investment company running the plan may be able to help with asset allocation.

Some plans offer free access to sophisticated software from Financial Engines or Morningstar that can help you pick among your available options. Once you have your target asset allocation, you’ll need to rebalance your portfolio, or return it to its original allocation, at least once a year. A good year for stocks could mean your portfolio is too heavily weighted with them, while a bad year means you need to stock up.

If that feels like too much work, you may have simpler options. Many plans provide a balanced fund, typically invested 60% in stocks and 40% in bonds, that provides automatic reallocation. The same is true for target-date funds, which are an increasingly popular choice. Pick the one with the date closest to your expected retirement year. If you’re 35, for example, you might opt for the Retirement 2045 fund.

It’s important, though, that you minimize costs because funds with high fees can leave you with significantly less money at retirement. The average target-date fund charged 0.73% last year. If you’re paying much more than that, and have access in your plan to lower-cost stock and bond funds, choose those instead.

Q&A: No wedding, no Social Security benefits

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Dear Liz: I’m a female who has been with her male partner for 20 years. We are not married. In the event one of us dies, is the other entitled to the partner’s Social Security benefits? Or do we have to be legally married to qualify for benefits?

Answer: Your genders don’t matter. Your marital status does. To get Social Security benefits based on the other person’s work record, you need to make it legal.

Marriage offers hundreds of legal, financial and estate-planning advantages, and Social Security is certainly one of those. With married couples, lower-earning partners may qualify for bigger benefit spousal benefits than the retirement benefits they would receive on their own work records. After a death, the surviving spouse gets the larger of the couple’s two benefits. Social Security makes up more than half of most elderly people’s income, so this is no small deal.

Q&A: Fiduciaries can help with estate trusts

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Dear Liz: I enjoyed your recent column about spendthrift trusts. You’re right that when parents assign the job of trustee to one sibling for the benefit of another sibling, it creates a hazardous situation that often results in a court battle. The appointed professional trustee should be a neutral party. You recommended a bank or trust company to fill the bill.

However, there is a third and often better option: a licensed professional fiduciary. There are about 600 in California. We are independent fiduciaries licensed by the state to manage clients’ assets in trusts and estates.

Professional fiduciaries will take the smaller trusts and estates, since banks and trust companies usually require a minimum of $1 million to $2 million under management before accepting a trust or remainder estate. Banks and trust companies also typically charge fees based on the amount of money under management, whereas California Licensed Professional Fiduciaries normally charge on a time-incurred basis.

Fiduciaries also give the beneficiary an annual accounting. A case I have now came to me when the sibling trustee failed to account for money spent for nine years.

Answer: Thanks for highlighting this option. Licensed professional fiduciaries aren’t available everywhere, but certified public accountants also can serve this function. The attorney who drafts the trust may have recommendations.

Q&A: Pros and cons of refinancing college loans

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Dear Liz: We took out parent PLUS loans to finance our two sons’ college tuition at private universities. We’ve received solicitations from a private lender offering to refinance. What are the pros and cons of doing so?

Answer: It rarely makes sense to replace federal student loans with private loans because the federal version comes with low rates, numerous repayment options, many consumer protections and the possibility of forgiveness. You lose all that when you refinance with a private loan.

Parent PLUS are a different story, however. Not only do they have higher rates (6.84% currently versus 4.29% for direct loans to undergraduates), but PLUS loans have fewer repayment options and no forgiveness.

If you have good credit and a solid employment history, you could dramatically lower your interest rate by refinancing with a private lender. Variable rates start at some lenders start under 2%, and fixed rates start under 4%. If you can’t pay the balance off within a few years, a fixed rate is probably your best option since rising interest rates could otherwise boost your payments.

A few private lenders even offer the option to have your child take over by refinancing your PLUS loan into his or her name.

You can shop for offers at Credible, a multi-lender online marketplace.