Ask Liz Weston

Get smart with your money

Q&A

Q&A: IRA contributions and tax deductions

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Dear Liz: I am changing jobs because of a layoff. I contributed to my former employer’s 401(k) to the extent possible. My new employer also offers a 401(k), but I won’t be eligible for a year.

I want to use an IRA in the meantime. I do not understand how I should answer the question on the tax form about whether my employer offers a retirement plan when I am determining how much of my IRA contribution I can deduct. My employer does, obviously, but I can’t participate yet. Advice, please?

Answer: You’re smart to continue your retirement savings while you wait to become eligible for the new employer’s 401(k). Missing even one year of contributions could cost you tens of thousands of dollars in lost retirement income.

When you’re not covered by an employer plan, all of your contribution to an IRA is typically deductible.

When you are covered, your contribution’s deductibility is subject to income limits. In 2015, the ability to deduct an IRA contribution phases out between modified adjusted gross incomes of $61,000 to $71,000 for singles and $98,000 to $118,000 for married couples filing jointly.

To be considered covered by an employer plan, you have to be an active participant, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. That means money has to be put into your account by you or your employer or both.

Here’s the twist: You’re considered covered for the whole tax year if you participated in a plan during any part of that year. So the IRS will consider you an active participant for 2015 because you were contributing to your former employer’s plan for part of this year.

If you start contributing to your new employer’s plan when you become eligible next year, you’ll be considered covered for 2016 as well.

You could decide not to contribute to the new employer’s plan until 2017 to preserve your IRA’s deductibility, but it probably makes more sense to start contributing to the new plan to get both the tax break and any match.

If your contribution to an IRA isn’t deductible, consider making a contribution to a Roth IRA instead.

In retirement, withdrawals from a regular IRA will be subject to income taxes while withdrawals from a Roth IRA will be tax free. In 2015, your ability to contribute to a Roth phases out between modified gross incomes of $116,000 to $131,000 if you’re single and $183,000 to $193,000 if you’re married.

Q&A: Credit score changes

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Dear Liz: My Discover card started including a complimentary credit score with my statement. My first report was 840. Each month since has been lower.

Two months ago it was 812 and the last one was 800. I have not applied for any new loans, cards or other credit. My limit on this card is $4,000, and I never charge more than $500 each month, which is paid in full. Why does my number keep dropping when I’m doing nothing different?

Answer: You may not be doing anything different, but the underlying information used to create your credit scores changes all the time.

The company that creates the leading credit scoring formula, FICO, says 8 of 10 people experience changes to their FICO scores by up to 20 points from month to month.

One factor that typically changes: the balances reported by your creditors. The fact that you pay your credit card in full is wise, but irrelevant to your scores.

The balances transmitted to the credit bureaus and used to calculate your scores may be the balances from your last statement, or from a random date in the previous month. If you have other credit accounts and loans, the balances from those factor into your scores as well.

Other things can also change. For example, an old, closed account may “fall off” your credit report, which could affect your credit utilization (how much of your available credit you’re using) as well as the average age of your credit accounts.

Also, every month your active accounts get older, which is typically a positive factor.

So you’ll see changes even when you’re looking at the same type of score from the same credit bureau.

You would see even more variation if you could see all your scores, since lenders use various formulas and pull scores from three credit bureaus.

Although the FICO score is the leading formula, that doesn’t mean the FICO you’re seeing is the FICO a particular lender is using. The lender may use a newer or older version of the formula — or one tweaked to the auto lending or credit card industry, for example.

You don’t have much to worry about, in any case. Scores over 800 indicate that you’re quite unlikely to default, so lenders should give you their best rates and terms if you do decide to apply for credit.

Q&A: Paying off student loans vs saving for retirement

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Dear Liz: I’m engaged to be married and need your advice on getting started in the world of shared finances.

My fiance is 43, I’m 31. He’s debt free, with a savings account but no retirement fund. I have $34,000 in student loans (consolidated at 4.25%) and it weighs heavily on my mind as I’m desperate to become debt free. I’m debt free otherwise with $10,000 in savings.

We both make good money but my income as a freelancer is sporadic, while his is steady with periodic bursts of additional income.

We want to be debt free as a couple, save up a solid emergency fund and start making up for lost time on retirement savings, all while being aware that a family and a house might not be far away.

He’s very supportive and wants to pay off my student loans. Should I let him and pay “us” back to the emergency fund or maybe a house down-payment fund? What’s our best course of action to start on a solid financial footing?

Answer: You’re already behind on retirement savings, which should have started with your first job. Your fiance is even farther behind.

Don’t let your zeal to repay your debt blind you to the very real risk that you might not be able to save enough for a comfortable retirement if you don’t get started now.

If your education debt consists of federal student loans, then your low rate is fixed. The interest probably is tax deductible, which means the effective rate you’re paying is just a little over the inflation rate. It isn’t quite free money, but it’s pretty cheap.

You don’t need to be in a rush to pay it off, particularly with all your other financial priorities looming.

Instead, get going on some retirement accounts. Your fiance should take advantage of his workplace plan, if he has access to one.

Most employer-sponsored workplace plans have company matches, which really is free money you shouldn’t leave on the table. An individual retirement account or Roth IRA can supplement the plan or be a substitute if he doesn’t have access to a workplace plan.

As a freelancer, you have numerous options for setting aside money for retirement, including Simplified Employee Pensions (SEP), Savings Incentive Match for Employees (SIMPLE) and solo 401(k)s that would allow you to contribute more than the standard $5,500 annual limit for an IRA.

Ideally, you would be saving around 15% of your income and your fiance 20% or more.

If you can’t hit those targets just yet, start saving what you can and increase your contributions regularly. Work your other goals around the primary goal of being able to afford a decent retirement.

Q&A: Delaying Social Security benefits

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Dear Liz: I’d like to get something straightened out. Between things that you and other columnists have said, we laymen have been told that if we wait until we’re 70 to start taking Social Security, we’ll get 8% more for each year we delay, and a total of 40% more than if we start taking it at our retirement age.

But the retirement age is 66, not 65. So there’s a four-year difference, which would produce an increase of only 32%. Even if the yearly increase is exponential (compounded), the total increase after four years would be 36%. So where does that 40% figure come from?

Answer: It didn’t come from this column, so it probably came from someone who was writing when 65 was the full retirement age.

As you note, the full retirement age is now 66 and will move up to 67 for people born in 1960 and later.

Delayed Social Security benefits max out at age 70, so there are fewer years in which a benefit can earn a guaranteed 8% annual return for each year it’s put off. Delayed retirement credits aren’t compounded, but the return is still better than you could get guaranteed anywhere else.

That doesn’t mean delaying Social Security past full retirement age is always the right choice. Social Security claiming strategies are complex, with a lot of moving parts, particularly if you’re married.

Before filing your application, you should use at least one of the free calculators (AARP has a good one on its site) and consider using a paid version, such as MaximizeMySocialSecurity.com, if you want to tweak some of the assumptions or if you have a particularly complicated situation.

Q&A: Social Security death benefits for a divorced spouse

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Dear Liz: I have heard conflicting information about Social Security death benefits for a divorced spouse. We divorced after 18 years and I have not remarried. What percent of his benefit is available to me?

My own Social Security is low as it started as a disability payment and then converted to regular Social Security when I turned 65.

To the best of my knowledge, my former spouse was getting the maximum Social Security benefit. He was a very high wage earner. Can you provide a simple-to-understand answer? I have received conflicting information from numerous sources including three separate people at the Social Security Administration.

Answer: It’s concerning that you would get varying answers from Social Security representatives, since the answer is simple given the facts you describe.

You should be entitled to a survivor’s benefit that equals 100% of what your ex was getting when he died, said economist Laurence Kotlikoff, a Social Security expert who co-wrote “Get What’s Yours: The Secrets to Maxing Out Your Social Security.”

Your marriage lasted the required 10 years, and you would be starting survivor benefits after your own full retirement age, so the amount would not be reduced to reflect an early start.

The fact that you’re unmarried is irrelevant in this case. Survivors’ benefits are available even to those who remarry, as long as the subsequent marriage happens after the recipient reached age 60.

That’s different from spousal benefits for the divorced, which aren’t available after remarriage at any age unless the subsequent marriage ends.

It’s possible that some or all of the people you queried didn’t understand your question or thought you were asking about spousal rather than survivor benefits. Another possibility is that they just don’t know the rules.

That’s not unusual, Kotlikoff said. Social Security regulations are complex, and not all of its employees are experienced. Kotlikoff said he often hears from people who have been told things that are “outright wrong, partially wrong, incomplete or confused.”

Educating yourself with Kotlikoff’s book and the Social Security’s own site may be a better solution than relying on its employees for answers.

Q&A: Personal loan debt vs credit card debt

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Dear Liz: I need to understand how credit reporting agencies treat personal unsecured loan debt versus credit card debt.

I am considering getting a personal loan from a reputable lender to pay down my credit card debt. The amount of my overall debt will still be the same, just in a different category. How will my credit score be affected?

Answer: What you need to understand is how credit scoring formulas treat installment debt (loans) versus revolving debt (credit cards). Credit reporting agencies maintain the credit reports used to create scores — but don’t bless (or curse) particular types of debt.

The personal loan’s overall effect on your credit scores is likely to be positive if you pay the loan on time. What you owe on an installment loan is typically treated more favorably than a similar balance on a credit card.

Installment loans have other advantages: You typically get a fixed rate, rather than the variable one charged on most credit cards, and your balance will be paid off over the term of the loan, which is usually three years. If you stop carrying balances on your credit cards, you should be in much better shape: free of debt with potentially higher scores.

Often the best place to get installment loans is from credit unions, which are member-owned financial institutions that may offer lower interest rates.

Avoid any lender that gives you a high-pressure sales pitch, that offers you a loan if you have bad credit or that pitches debt settlement, which is far more dangerous to your finances than a personal loan.

If the lender tries to tell you about a new “government program” that wipes out credit card debt or tries to collect big upfront fees, you’ve stumbled onto a scam.