Ask Liz Weston

Get smart with your money

Q&A

Q&A: Deferred compensation plans

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Dear Liz: I’m 54 and plan on retiring at 55 with a government pension. I have about $450,000 in a 457(b) deferred compensation plan. I owe about $220,000 on my home. I would like to pay off my 15-year, 2.5% interest mortgage. This would free up $1,900 a month and leave us debt-free. Everyone I’ve spoken to says this is a bad idea since I’d lose my mortgage interest deduction and I’d be “investing” in a low-interest vehicle (my mortgage). My only other obligation is my daughter’s college education, and I’m paying that in cash. Am I crazy to pay off this mortgage?

Answer: You’re not crazy, but you probably haven’t thought this all the way through.

The money in your deferred compensation plan hasn’t been taxed. Withdrawing enough to pay off your mortgage in one lump sum would shove you into a higher tax bracket and require you to take out considerably more than $220,000 to pay the tax bill. You could easily end up paying a marginal federal tax rate of 33% plus any applicable state tax — all to pay off a 2.5% loan.

There are a few scenarios where using tax-deferred money to pay off a mortgage can make sense. Some people have so much saved in retirement plans that the required minimum distributions at age 70½ would push them into high tax brackets and cause more of their Social Security to be taxed. They also may have paid down their mortgage to the point where they’re no longer getting a tax break.

In those instances, it may be worth withdrawing some money earlier than required to ease the later tax bill. The math involved can be complex, though, and the decisions are irreversible, so anyone contemplating such a move should have it reviewed by a fee-only financial advisor who is familiar with these calculations.

In fact, it’s a good idea to get an objective second opinion from a fiduciary any time you’re considering tapping a retirement fund. (Fiduciaries are advisors who pledge to put your interests ahead of your own.)

During your meeting, you also should review the other aspects of your retirement plan. How will you pay for health insurance in the decade before you qualify for Medicare? If you’re a federal employee, you should be eligible for retiree health insurance but your premiums may rise once you quit work. If you’re planning to buy individual coverage through a healthcare exchange, what will you do if that’s yanked away or becomes unaffordable? How will you pay for long-term care if you need it, since that’s not covered by health insurance or Medicare?

You can get referrals to fee-only financial planners from the National Assn. of Personal Financial Advisors at napfa.org. You can find fee-only planners who charge by the hour at Garrett Planning Network, garrettplanningnetwork.com.

Q&A: Too many cards?

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Dear Liz: My husband and I have opened accounts to take advantage of 0% interest financing for special purchases. These accounts are paid in full prior to the end of the promotional period and we don’t use them again. I’ve read to not ever close any accounts, but am nervous about having so many accounts open with such high limits. Is there potential for issuers to stop granting us credit because we have so much available? Are we at greater risk for identity theft with all of these open accounts?

Answer: People used to believe that closing accounts could somehow help their credit scores. Credit scoring companies and experts have done their best to combat that myth, but in doing so have left some people thinking that they can’t ever close unneeded accounts. That’s not true either.

Your credit scores won’t be hurt by having “too many” accounts with high limits. That’s generally a good thing, since multiple lenders have deemed you creditworthy. You get the most credit scoring benefit, though, from accounts you’re actively using.

Leaving unused accounts open can leave you more vulnerable to fraudulent account takeover. At the very least, it adds to the hassles in your life, since you have to keep an eye on all your accounts. And conceivably a lender could balk at seeing a lot of unused credit lines, even if it didn’t hurt your scores.

You don’t want to close accounts if you’re trying to improve your scores or in the market for a major loan, such as a mortgage or auto loan. Otherwise, though, you shouldn’t worry about closing an account now and then if you’re not using it.

Q&A: Social Security benefits for spouses can pump up household income

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Dear Liz: I have a friend who has a selfish, controlling husband. When talking with her recently, she told me she got only $300 a month from Social Security based on her work history while her husband gets $1,800. I told her she should be getting $900, half of his monthly amount, as a spousal benefit. I guess he thought if she got more it would reduce his check. I told her the $900 would be in addition to the $1,800 he gets.

She has been collecting her smaller benefit for seven or eight years. Does she have any recourse? I doubt he would take her to the Social Security office but maybe her daughter would.

Answer: It sounds like the husband’s greed has cost this household tens of thousands of dollars in lost benefits.

Spousal benefits (and divorced spousal benefits) do not reduce the primary worker’s check. This benefit, as you correctly told your friend, is available in addition to what her husband gets. Spousal and divorced spousal benefits can be up to half of the primary worker’s benefit. The amount that spouses and divorced spouses get is reduced if they start benefits before their own full retirement ages.

Your friend can’t get back the years of benefits she missed out on, but she should ask the Social Security Administration to switch her to the larger benefit. She can contact the administration at 1-800-772-1213.

The death of a student loan co-signer could have financial ramifications for the borrower. (Colleen Riemer / For The Times)

Q&A: When a student loan co-signer dies

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Dear Liz: I have a friend who recently died after co-signing a student loan for her son. She was making the payments. Does that loan go to her son now to repay?

Answer: Possibly. Another possibility is that her estate is on the hook.

It all depends on the loan agreement, which varies from private lender to private lender. (We know this is a private loan because federal student loans, which have many more consumer protections, do not require co-signers.)

In many cases, nothing happens if the other borrower takes over the payments and continues to make them on time. Some lenders, however, have a contract clause that makes the balance of the loan due immediately. In the past, lenders also could consider a death to be an “automatic default” that could seriously damage the living borrower’s credit. Fortunately, the Consumer Financial Protection Bureau pushed lenders to change their policies on new and existing loans so that co-signer deaths no longer trigger such defaults.

If you’re close to this young man, you should urge him to check the contract and to contact the lender.

Q&A: Deducting medical expenses racked up by another person

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Dear Liz: I recall reading that an individual could deduct unlimited medical expenses for another person, as long as the provider was paid directly. Looking at IRS Publication 502, it appears that now only a “qualifying relative” (the closest I could get to eligibility) is eligible for a deduction on another person’s return. I’m asking because my sister is helping with my medical expenses, and I had hoped to give her a deduction. Her tax person is insistent that she cannot take a deduction for my expenses. I don’t qualify under the “qualifying relative” clause because she doesn’t provide more than half my support. Have I always misinterpreted this rule, or has the rule changed recently?

Answer: You’re confusing the medical deduction rules with the gift tax exemption.

The gift tax rules require givers to file tax returns for gifts in excess of $14,000 per recipient, unless the giver paid medical or tuition expenses directly to a provider (such as a hospital or college). Paying these expenses isn’t considered a gift, so your sister can pay an unlimited amount of your medical bills without having to file a gift tax return or counting those gifts toward her lifetime exclusion amount, which is currently $5.49 million. Gift taxes aren’t owed until that lifetime exclusion amount is exceeded.

Your sister can deduct medical expenses from her income taxes only when she pays them on behalf of herself, her spouse, her dependents and her “medical dependents.” Claiming someone as a dependent or medical dependent requires that she provide at least half that person’s support. Only the amount of qualifying medical expenses that exceed 10% of her adjusted gross income in 2017 would be deductible.

Q&A: Why a reverse mortgage might be a good idea for some older homeowners

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Dear Liz: I recently retired to a small house I bought 30 years ago. I refinanced four times to get the rate down from 11% to 3.5%. This provided me with a low monthly mortgage (just under $450), but my current 30-year loan won’t be paid off until I’m 92. I’ll be 67 in two months, and just received an inheritance of $400,000 following the death of my parents. My only income is $2,000 a month from Social Security and a monthly pension check of $1,100, although I do have an IRA that should be worth roughly $170,000 by July.

I’m thinking about paying off the $90,000 remaining on my mortgage, which would allow it to be passed on to my sister, nephew (or whomever) without any complicated bank or loan issues. It also would free up that mortgage payment for other household expenses. The house needs some work, such as a new carport, double-pane windows, proper insulation, deck repair and maybe termite work, all of which will probably eat up the better part of $100,000. Is it worth keeping the loan just to maintain the tax deduction or does it makes financial sense to pay it off?

Answer: Keeping a mortgage just for the tax deduction doesn’t usually make much sense. Here’s why: If you’re in the 25% federal tax bracket, you’re getting back only about 25 cents for each dollar in interest you pay. Most homeowners get even less back, and many don’t get any tax advantage from their mortgages at all.

It can make sense, though, to keep a mortgage to preserve liquidity. Younger people, especially, should be wary of tying up most of their net worth in a home if that equity would be hard to tap in an emergency. Home equity lines of credit offer one way to access that equity, although lenders can freeze or reduce those lines on a whim.

Because you’re over 62, you could consider paying off the loan and then setting up a reverse mortgage line of credit.

An FHA-insured reverse mortgage line of credit can’t be shut down once it’s established, as long as you abide by the loan rules (such as paying your property taxes and insurance, and keeping the home in good condition). In fact, the amount you can borrow can increase over time with a reverse mortgage credit line. You don’t have to make monthly principal and interest payments on the money you borrow with a reverse mortgage.

Any amount you borrow will grow over time, typically at variable interest rates, and will have to be repaid when you die, sell or permanently move out of the home. That would complicate leaving the house to your heirs, but if the amount you owe is greater than the home’s worth, your heirs aren’t on the hook for the difference with an FHA-insured reverse mortgage, also known as a Home Equity Conversion Mortgage.

In any case, preserving an inheritance probably shouldn’t be your top priority. You should focus instead on preserving your quality of life and your financial flexibility.

Reverse mortgages have gotten safer and less expensive in recent years, but you would need to exercise discipline not to waste the money you borrow on frivolous purchases. You want that equity to be available for you when you need it, such as for nursing home or other long-term care expenses.

You would be required to get counseling before applying for a reverse mortgage, but you also should talk to an independent, fee-only financial planner to make sure this approach makes sense.