Q&A: When a lower credit score might not be cause for alarm

Dear Liz: I sold my house, paid off my mortgage and then got a new mortgage for another home in 2021. When I applied for the new mortgage, my credit score was 830. After buying the home, my score dropped to the low 700s. It’s gone up only 2 points in seven months. I have no other debt. What’s going on?

Answer: Remember, you don’t have one credit score, you have many. When you applied for a mortgage, you typically would be shown three older-generation FICO scores — one from each of the three major credit bureaus (Equifax, Experian and TransUnion). Your interest rate would have been based on the middle number. If your scores were 840, 830 and 700, for example, your rate would be based on 830. Any score over 740 typically gets the best rate and terms on a mortgage, all else being equal.

The score you’re monitoring now was probably created from a different scoring model. If the score is a FICO score, it probably was created from an updated formula such as FICO 8 or FICO 9. It’s also possible that you’re viewing a VantageScore 3.0 or 4.0. VantageScore is a FICO competitor.

If you’ve been monitoring the same score all along and it actually dropped 100 points since your application, then something else is going on. Please check your credit reports from all three bureaus and look for a skipped payment, a collection or some other serious problem.

Q&A: Where to park cash?

Dear Liz: I turned 72 in December and took my first required minimum distribution. With the goal of purchasing property next year, should I put the funds — $6,000 — in my Roth IRA or just put it in my bank savings account? Also, should I convert my traditional IRA to a Roth or just leave it alone?

Answer: To contribute to an IRA or Roth IRA, you must have earned income such as wages, salary or self-employment income. If you don’t have earned income, your contribution would be considered an excess contribution that could incur a 6% penalty for each year the money remained in the account.

You don’t have to be working to convert a traditional IRA to a Roth, but there’s typically not much reason to do so at this point unless you intend the money to go to your heirs and want to pay the income taxes rather than have them do so. Even then, you should run this idea past a tax pro or a financial planner since conversions can create other problems, such as higher Medicare premiums.

Q&A: HELOC situation improves

Dear Liz: Your recommendation that a retired couple consider a home equity line of credit to pay for home repairs astonished me. According to news reports, HELOCs are becoming harder and harder to find. Banks that still offer them have gotten stricter. And to suggest a reverse mortgage for a couple who only need $10,000, I think, is not the best option for them.

Answer: Lenders did tighten their requirements for HELOCs after the pandemic began, and some stopped offering them entirely. But the situation is starting to ease, thanks to rising levels of home equity and a generally strong economy.

The original letter writer’s spouse had proposed using a low-rate credit card to pay for a new furnace and water heater. Using a low-rate card isn’t a bad option if the balance can be paid off quickly, but could become expensive otherwise. Low rates are typically teaser rates that expire after a certain period. The couple then could try to roll the balance onto another low-rate card, but there’s no guarantee they would be approved for such a balance transfer or that they would get a large enough credit limit.

You’re quite right that a reverse mortgage wouldn’t be a great solution if the couple needed only $10,000, but the letter writer indicated they had little in savings. A reverse mortgage or line of credit could provide an ongoing source of funds for those with few other options.

Q&A: Social Security and government pensions

Dear Liz: You recently mentioned the windfall elimination provision that affects pensions from jobs that don’t pay into Social Security. I’m wondering what those jobs are. Are they just part of the gig economy, or is there some other category of jobs that don’t pay into Social Security?

Answer:
Gig economy jobs are supposed to pay into Social Security, just like the vast majority of other occupations. People with gig jobs are often considered to be self-employed, so instead of paying just 6.2% of their gross wages into Social Security like most workers, they also pay the employer’s 6.2%, for a total of 12.4% of their earnings.

Some state and local governments have their own pension systems that don’t require workers to pay into Social Security. People who get pensions from those systems and who also qualify for Social Security benefits from other jobs can be affected by the windfall elimination provision, which can reduce their Social Security benefit. They also can be affected by the government pension offset, which can reduce or even eliminate spousal and survivor benefits from Social Security. Here’s an example:

Dear Liz: I am 59, retired, and receive a pension of approximately $150,000 a year. My husband receives a small pension, about $1,000 a month, and Social Security disability due to a diagnosis of Stage 4 lung cancer. I am the sole financial support of my 88-year-old destitute mother, who requires care that costs approximately $5,000 a month. I retired earlier than anticipated to care for my ailing mother and husband.

Although I worked many years where I paid into Social Security, I knew I would receive only about half of my Social Security check due to the windfall elimination provision that affects pensions received from jobs that didn’t pay into Social Security. What I didn’t know is that when my husband passes, I will receive no survivor benefits from his 41-plus years of paying into the system.

Our entire retirement planning was based on his Social Security combined with my pension. He’s just a few months from passing, and I will not be receiving anything, which will immediately put me in an untenable financial position. How is it that after 30 years of marriage I will receive nothing because I have a pension? This just doesn’t seem right. Do I have any options?

Answer: Your situation shows why it’s so important to get sound advice about Social Security before retiring because many people don’t understand the basics of how benefits work.

Even if you didn’t have a pension, for example, your income would have dropped at your husband’s death. When one spouse dies, one of the couple’s two Social Security benefits goes away and the survivor gets the larger of the two checks the couple received.

Your pension is much, much larger than the maximum you could have received from Social Security in any case. If you can’t get by without your husband’s benefit, consider ways to reduce your expenses. Because your mother is destitute, she may be eligible for Medicaid, the government healthcare program for the poor. Unlike Medicare, Medicaid pays the costs of nursing home and other custodial care expenses. Contact your state Medicaid office for details.

Q&A: What is the capital gains tax, and how big a bite does it take?

Dear Liz: We own stocks with enormous capital gains — as in, six figures or more. The tax would be a lot. Any advice on how to limit the tax bite? Our income consists of Social Security and a teacher’s pension.

Answer: Capital gains taxes may be less of a problem than you fear. If your taxable income as a married couple is less than $83,350 in 2022, your federal tax rate on long-term capital gains is zero. (Long-term capital gains apply to profits on stocks held one year or more.) If your taxable income is between $83,350 and $517,200, your federal capital gains tax rate is 15%.

In addition, you may owe state taxes. California, for example, doesn’t have a capital gains tax rate and instead taxes capital gains at the same rate as ordinary income.

Capital gains aren’t included when determining your taxable income, by the way, but they are included in your adjusted gross income, which can affect other aspects of your finances. A big capital gain could determine whether you can qualify for certain tax breaks, for example, and could inflate your Medicare premiums. That’s why it’s important to get good tax advice before selling stocks with big gains.

A tax pro can discuss strategies that might reduce a tax bill, such as offsetting gains with capital losses by selling any stocks that have lost value since you purchased them. You also could consider donating appreciated shares to qualifying charities. If you itemize your deductions, you can deduct the fair market value of these shares. The write-off is typically limited to 30% of your adjusted gross income for the year, although if you donate more you can carry forward the excess deduction for up to five years.

All this assumes that these shares aren’t held in retirement accounts. Withdrawals from retirement accounts are typically taxed as ordinary income and don’t benefit from the more favorable capital gains rates. If the stocks are in an IRA and you’re at least 70½, however, you could make qualified charitable distributions directly to nonprofits and the distributions wouldn’t be included in your income. Again, this is something to discuss with a tax pro before taking action.

Q&A: It’s easy to squander a windfall. How to make the money work for you

Dear Liz: I’m receiving a $150,000 inheritance soon. After I pay all of my debt, I’ll have approximately $70,000. I’m 51, single with no children and my net income is about $4,400 a month. I’ve rarely been wise or successful with my finances. I have no prior savings, don’t own a home and drive a five-year-old car. Do you have any thoughts for the remaining funds?

Answer: It’s never too late to get better with money. Now would be a great time to examine why you got into debt and what you need to change so that doesn’t happen again.

Windfalls tend to disappear pretty quickly, and it would be a shame if you found yourself back in debt in a few years with nothing to show for your inheritance.

Nonprofit credit counseling agencies affiliated with the National Foundation for Credit Counseling (www.nfcc.org) usually offer help with budgeting, or you could book some one-on-one sessions with an accredited financial counselor or accredited financial coach. You can get referrals from the Assn. for Financial Counseling & Planning Education at www.afcpe.org.

Paying off high-rate debt such as credit cards is a great use of a windfall. Think twice about paying off lower-rate debts such as student loans or car loans, however. You probably have better uses for that money.

You likely need to start saving aggressively for retirement.

If you have a 401(k) at work with a match, you should be taking full advantage of that. (You might draw from your inheritance to replace some of the money that’s being directed into your retirement account.)

Otherwise, you can put up to $7,000 into an IRA or Roth IRA — the usual limit is $6,000, but people 50 and older can make an additional $1,000 catch up contribution. You can dedicate even more money for retirement by opening a regular brokerage account and investing through that.

A windfall also can help you create an emergency fund equal to three to six months’ worth of expenses, as well as provide a starter savings account for your next car.

Resist the urge to replace the one you have, though, because with proper maintenance you should be able to drive the one you have for several more years. Buying new cars every few years is hugely expensive and generally unnecessary since today’s cars can easily drive without major problems for 200,000 miles or more, according to J.D. Power & Associates.

Q&A: All investments involve risk

Dear Liz: I want to protect principal in my modest retirement savings account for future needs. I’ve been in cash and money market funds, but if the recent surge in inflation continues, purchasing power could decrease 25% or more over the next five years. Certificates of deposit and Treasury Inflation-Protected Securities (TIPS) tie money up for long periods and emergency use would result in significant loss. I’ve examined diversifying into real estate, commodities, foreign currencies, gold, but they all go up and down. Can principal be protected from loss and inflation?

Answer: No.

Investments that protect your principal typically have returns that trail inflation. Even though your principal is protected from one kind of loss, you’re all but guaranteed the loss of buying power over time. For inflation-beating returns, you need to take some risk.

Young people with decades until retirement should keep most of their retirement savings in stocks, but even those in retirement typically need to have some exposure to the stock market to preserve growth and buying power. A fee-only, fiduciary financial planner could give you individualized advice about how much risk is appropriate for you to take.

Q&A: Mortgage payoff creates options

Dear Liz: My wife and I just paid off our mortgage. What’s the correct thing to do now with the amount we used for the mortgage payments?

Answer: Congratulations! Paying off a mortgage is a big deal, so consider using some of your freed-up money to celebrate in whatever way seems appropriate.

Many Americans don’t have adequate retirement or emergency savings, so those should be high priorities along with paying off any other debt you might have.

If you’re in good shape, though, consider boosting your charitable contributions. Studies show that generosity contributes to happiness, and spending money on others often makes us feel better than spending on ourselves.

Q&A: When pension trumps Social Security

Dear Liz: I am in my third marriage. My first two marriages each lasted 10 years. My spouses worked in jobs requiring them to pay into Social Security. I am currently retired (since 1999) and worked for a city government my entire career. I currently receive a pension from the city. Am I entitled to receive anything from Social Security for the time I was married to my previous spouses? It seems only fair since I had to pay each of them spousal support.

Answer: That’s a novel argument! Alas, the Social Security system doesn’t care about the details of your divorce decrees.

You can call Social Security and ask if you’re eligible for a benefit, but don’t get your hopes up if your pension comes from a job that didn’t pay into Social Security. A provision known as the government pension offset probably would wipe out any divorced spousal or divorced survivor benefit you might receive.

Q&A: Taxes on retirement account withdrawals

Dear Liz: I would love to give my grandchildren money, but I don’t want to pay the income tax on withdrawals from my IRA or 401(k). Will they get it tax-free when I die?

Answer: Unfortunately, no.

Withdrawals from retirement accounts are generally taxable, whether the person making the withdrawals is the original contributor or an heir. Furthermore, non-spouse beneficiaries of retirement accounts generally must withdraw the money within 10 years.