Ask Liz Weston

Get smart with your money

Q&A

Q&A: How to make retirement saving a priority

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Dear Liz: One thing I like about saving for retirement with an IRA is that I can wait until April 15 of the following year and then just contribute a lump sum for whatever I can afford to put in that year. Is there anything similar with 401(k)? Or do I have to have the contributions come out piecemeal with payroll deductions? I keep revising the percentages, but then there is a lag time between when I revise and when that money is taken out. It is a hassle. It would be much easier to just make a lump sum contribution at the end of the year to my 401(k).

Answer: Many people have unpredictable incomes and variable expenses that make planning tough. If you have a steady paycheck, though, you’d be smart to pay yourself first by making your retirement contributions a priority.

It’s generally smart to contribute at least enough to get the full company match, even if that means cutting back elsewhere. Matches are free money that you shouldn’t pass up. If you can contribute more, even better. For many people, retirement plan contributions are one of the few available ways they can still reduce their taxable income.

If you discover after the end of the year that you could have put in more, you can still make a lump sum contribution to an IRA. Since you have a plan at work, your contribution would be fully deductible if your modified adjusted gross income is less than $64,000 for singles or $103,000 for married couples filing jointly. The ability to deduct the contribution phases out so that there’s no deduction once income is above $74,000 for singles and $123,000 for couples.

Q&A: Here’s a case where taking retirement funds early might make sense

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Dear Liz: My wife and I are both retired and receiving annuity payments. In addition, we have about $1.3 million in traditional IRAs and $350,000 in another annuity that will pay us each about $1,000 per month. We are moving from Texas to Arkansas sometime in the next year. Texas has no state income tax and pretty high property taxes, while Arkansas has lower property taxes but about 6% income tax. We plan to put down about $200,000 on a new home and obtain a mortgage for about $350,000 at about 4% interest.

Does it make sense to withdraw money from the IRA to pay down the amount we need to borrow for the mortgage? I can withdraw about $90,000 without putting us into the next higher federal tax bracket, if that makes any difference, and end up saving $5,400 in Arkansas income tax at the same time.

By my calculations, the return on the $90,000 would be almost $8,000 every year in reduced mortgage payments if we took out a 15-year mortgage. If we did the 30-year loan, that savings would be over $5,000. I don’t think we’ll achieve the same returns on $90,000 leaving those funds invested as they are in bonds or cash.

Answer: It usually doesn’t make sense to tap retirement funds to pay down a mortgage, but your case may be one of the exceptions. You have enough saved that the withdrawal won’t claim a big chunk of your available funds and leave you cash-poor.

We’ll assume you’re over 59½ and won’t face penalties for early withdrawal. If that’s the case, then you’ll also be facing required minimum distributions within a few years. These mandatory withdrawals, which must start after you turn 70½, would subject at least some of this money to taxation. The question is whether you want to pay those taxes now or later, and you’re making a pretty good case for now.

Before you withdraw any money from a retirement fund, however, you should consult with a tax pro or a fee-only financial planner, or both. Mistakes made in early retirement often have irreversible consequences, so you want an objective second opinion before you proceed.

Q&A: Bad Social Security math

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Dear Liz: Regarding when to begin receiving Social Security payments: I would think that people should begin taking payments as early as possible if they can invest it rather than spend it, as a lot of money is “left on the table” between ages, say, 62 and 70. Your thoughts?

Answer: That argument was more compelling a few decades ago when you could get a 7% or 8% return on an FDIC-insured certificate of deposit. These days, there’s no investment that offers a guaranteed return as high as what you’d get from delaying the start of Social Security.

The “take it early and invest” approach also ignores the longevity insurance aspect of Social Security benefits. Most people face a real risk of outliving their savings, which could leave them relying on Social Security for most if not all of their income. Maximizing Social Security benefits by delaying your application can help you live more comfortably, should that happen.

Also, starting early can cause harm to whichever spouse survives the other. When one spouse dies, one of the two Social Security checks the couple was receiving will stop. The remaining spouse will get only the larger of the two checks, which is known as a survivor’s benefit. Maximizing that benefit can help ease the shock of going from two checks to one, so financial planners generally recommend that the higher earner in a couple delay his or her application if possible.

Q&A: Tax take on inherited house

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Dear Liz: In a recent column, you quoted an attorney saying that if an inherited home in a trust is sold for its value at the date of death, the trust won’t owe capital gains. We sold our family’s house in 2007 within a month of my mother’s death and the government took half. Fortunately it was a really valuable house in Brentwood, but what are you talking about? I must be missing something.

Answer: If the government took half, then estate taxes — rather than capital gains taxes — probably triggered that hefty bill.

When your mother died, the estate tax exemption limit was much lower — $2 million, compared with the current $11.4 million. The top federal estate tax rate then was 45%, compared with 15% for capital gains.

Q&A: Inflation and Social Security

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Dear Liz: Every time someone asks a question about when to start taking Social Security, all you financial advisers make your calculations based on the 7% to 8% annual increase you get by delaying between ages 62 and 70. What you never mention is that once you start getting Social Security, you also start getting the cost of living annual adjustments. I started at 63 and my monthly check has already gone up 5% and it’s compounded. In this era of higher inflation, that pushes out the break-even point into an age in the late eighties. You need to add that into your advice.

Answer: Surveys have shown that most people are happy with their decision to start Social Security, even when they started it early. Perhaps they don’t know what they’re missing.

The researchers who have studied Social Security claiming strategies have factored inflation into the mix, as well as longevity, investment returns and taxes (there’s something known as the “tax torpedo,” which can jack up marginal tax rates for middle-income Social Security recipients). The assumptions can differ, but the results don’t: The majority of people benefit from delaying. In today’s low-interest-rate environment, many researchers say the vast majority are better off.

Another factor the researchers consider — and that many early starters don’t — is what happens to the surviving spouse. When one member of a married couple dies, one of their two Social Security checks goes away and the survivor has to get by on a single check, which will be the larger of the two. That’s why it’s so important that the higher earner in a couple try to delay as long as possible, because it will boost the check for the person left behind.

That doesn’t mean single people should start early, however. Single people tend to have less savings and wealth than married people; they’re more likely to be poor than married couples, and single women have a higher poverty rate than single men. If you wind up getting most if not all your income from Social Security, you’ll want that check to be as large as possible.

As for your phrase, “this era of higher inflation” — yes, the 2.8% cost-of-living boost was higher than the 2% increase of the prior year. The year before that, the inflation adjustment was close to zero, and it was actually zero in 2010, 2011 and 2016. Annual adjustments over the last 20 years have averaged just a little over 2%. That’s not a lot to get excited about.

Selling mom’s house may require an appraisal first

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Dear Liz: My mother recently passed away. The title to her home was held in the family trust. My siblings and I are in the process of clearing out the house in preparation for a sale. Do we need to obtain a “step-up” basis appraisal before the sale to use in determining capital gain on the home? We do not know the original price paid for the home in the late 1960s. Alternatively, could we use an appraisal made in November 2016 as a basis and apply the one-time $250,000 capital gain exclusion?

Answer: You definitely need to establish a property’s value for income tax purposes soon after the owner’s death. If you sell within a year, you could use the fair market value as the home’s new basis, said estate planning attorney Burton Mitchell.

“There is no law about this one-year period,” Mitchell said. “It is just what is often used by both IRS and practitioners.”

You may want more certainty or think the sale may not happen within a year. Estate planning attorney Jennifer Sawday of Long Beach recommends you immediately reach out to a real estate agent to get a broker opinion value letter or hire a certified real estate appraiser to determine the exact value of the home at the date of your mother’s death.

“If you are able to sell the home close to or not much higher than the date of death valuation, the trust will not have any capital gains,” she said. “Plus real estate expenses and other trust administration fees will be computed against the home selling price to minimize any capital gains as well.”

A tax pro can help you figure this all out. The costs of hiring tax and legal help can be charged to the estate.

All the gain in value from the past five decades won’t be taxed. In some parts of the country where home prices are high, such as California, that step-up in basis is far more valuable than the $250,000 home sale exclusion, which you wouldn’t be able to use anyway unless you lived in and owned the home for at least two of the previous five years.