Q&A

Q&A: Sorting out IRA taxes

October 24, 2022 By Liz Weston

Dear Liz: My traditional IRA contains both pre-tax and after-tax contributions. (Some years I was ineligible to deduct contributions because I was participating in an employer’s retirement program.) Now I am retired and am considering making Roth conversions from the traditional account. I admit I was a little careless about keeping track of the total after-tax contributions. For the past 10 years or so, I have been using one of the more popular tax programs and was letting it track the tax basis and file the Forms 8606. I recently reconstructed all of my IRA contributions since 1985 to check the basis and discovered that the amount the software had calculated was short by about $15,000. Is it possible to correct this so that I don’t end up paying tax on the wrong basis?

Answer: Yes, but this could be a difficult process, according to Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

As you know, when making Roth conversions you’re required to pay income taxes on the portion of your IRA that represents deductible contributions plus any earnings. But you don’t have to pay taxes on the portion of your account that represents your nondeductible contributions — that is what is known as your tax basis. A higher basis means less taxes, so correcting this may be worth the effort.

You’ll have to go back and correct each Form 8606, working from the oldest year, Luscombe says. The corrections need to reflect the traditional IRA contributions for that year, including the dollar amount, any deduction taken and the return of any excess contribution.

Send the corrected 8606s to the same service center where you will send the tax return for the conversion. If you’ve taken any distributions from the account, your calculations for the taxable portion may be in error as well. You can correct that for the past three tax years, but you won’t be able to recover the excess tax paid in any previous years, Luscombe says.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.

Q&A: Here’s a tip to take advantage of rising interest rates

October 24, 2022 By Liz Weston

Dear Liz: Now that interest rates on savings accounts have started to rise, I have a quick tip for you to share: Check the rate you’re getting on your accounts! I discovered my online bank changed its account structure a few years back, and legacy high-yield savings accountholders aren’t getting the recent increases. I was earning only a paltry 0.3% rate, while people who opened accounts more recently were earning over 2%. I’m sure many customers like me assumed they had high-yield accounts, since that’s what they opened originally, but they are, in fact, not receiving competitive rates.

Answer: Thank you for the heads-up. People who have certificates of deposit also should check whether those CDs have matured. Some banks renew the CDs at competitive rates, while others dump the proceeds in a low-rate account. A little vigilance can help you squeeze out a much better rate of return.

Q&A: ‘Fee based’ vs. ‘fee only’ financial planners: There’s a big difference

October 10, 2022 By Liz Weston

Dear Liz: How do you find a fee-based financial planner? I just inherited a lot of money, and trying to figure out our future is stressing me out.

Answer: That’s understandable. Getting sound advice can mean the difference between growing your newfound wealth and wasting it. But finding a good, honest, competent planner requires some work.

Most advisors aren’t fiduciaries, so they aren’t required to put your interests ahead of their own. Instead, they can recommend investments that cost more or perform worse than available alternatives, simply because the recommended investments pay them more.

Such advisors often call themselves “fee based,” hoping you’ll confuse them with “fee only” planners. Fee-only planners are compensated only by the fees you pay; they don’t accept commissions or other compensation that could influence their advice.

The National Assn. of Personal Financial Advisors and the Alliance of Comprehensive Planners are two organizations that represent fee-only planners, many of whom charge a percentage of your investable assets. You can find fee-only planners who work on an hourly basis at Garrett Planning Network and those who charge monthly retainer fees at XY Planning Network.

Interview at least three candidates. Ask them how they are paid and what your “all-in” costs — their fees plus the cost of investments they recommend — are likely to be. Ask about, and verify, their credentials. (You can check a certified financial planner’s status at cfp.net/verify-a-cfp-professional.) Find out about their education and experience, including whether they’ve advised people similar to you.

They should be willing to assert in writing that they will be fiduciaries. Finally, check their backgrounds, including their disciplinary history, at BrokerCheck.finra.org.

Q&A: Health savings account rules

October 10, 2022 By Liz Weston

Dear Liz: I established a health savings account when I was self-employed using an HSA-compliant healthcare plan. Now I am employed. My employer does not offer a health plan that was designated as an HSA, but my deductible is $7,000, higher than the minimum for an individual. Can I continue to contribute to my existing HSA?

Answer: Unfortunately, no. To contribute to an HSA, you must be covered by an HSA-compliant high-deductible healthcare plan, and you may not be covered by other health insurance, including Medicare.

HSAs were created as a way to encourage people to choose high-deductible health insurance plans, but many people use them as an additional way to save for retirement. HSAs have a rare triple tax break: contributions are pretax, the account can grow tax deferred and withdrawals are tax free if used to pay qualifying healthcare expenses.

Unlike flexible spending accounts, which are “use it or lose it,” HSAs allow people to roll unused balances over from year to year. Plus, balances can be invested for long-term growth. Many people value these tax advantages so highly that they pay medical expenses out of pocket, leaving their HSA balances to grow for the future.

But HSA-compliant health insurance policies must meet certain criteria, including a minimum deductible of $1,400 for individuals and $2,800 for families for 2022. (The average deductible in 2021 was $2,349 for individuals and $5,217 for families, according to KFF, the healthcare research organization formerly known as the Kaiser Family Foundation.) The maximum out-of-pocket limit — including deductibles and co-pays, but not premiums — is $7,050 for individuals or $14,100 for families in 2022.

As you can see, you’ve wound up with the worst of both worlds: a very high deductible with no option to save in an HSA. Perhaps your employer is compensating you so handsomely in other areas that you can overlook this deficit in your benefits. If not, it might be time to look for an employer who can offer more.

Q&A: Investigate a credit score drop

October 3, 2022 By Liz Weston

Dear Liz: I had an 836 credit score as of last week. I’m a business owner and have been using my company credit card to pay bills on a large project to get 2% cash back. I charged $52,000 of the $70,000 I have available on that one card. (I have about $175,000 available across the three business cards I have) and my credit score went down to 699! I pay my cards off within days of receiving my statements. Is this a bad use of my cards? How long do you think it will take to get my score back up? Side note: I don’t need any more credit, but my business line of credit is coming up for renewal and I am buying a new truck in two months. Do you think this will be an issue?

Answer: Lower scores could cause you to pay more for credit, so it’s worth fixing this issue promptly.

There’s nothing wrong with using your cards to get rewards, as long as you’re paying your balances in full and not using too much of your available credit. Ideally, you’d use less than 10% of the limit on any card at any given time. (Credit scoring formulas pay close attention to the amount of credit you’re using on each revolving account as well as how much of your available credit you’re using overall.)

If you need to use a lot more of your credit limit, consider making more than one payment a month. Some people make bi-weekly or even weekly payments to keep their balances low.

(The balances that factor into your scores are typically the amounts that you owe on your statement closing date.)

Credit card issuers typically report to the credit bureaus every month, so it shouldn’t take more than 30 days for lower balances to improve your scores.

It’s a little unusual, however, for a business credit card to affect your personal credit scores. Typically, business accounts don’t show up on your credit reports, even if you used your personal credit history to apply for the cards. You may want to pull your three credit reports from AnnualCreditReport.com to see if other problems may have contributed to your score drop.