Ask Liz Weston

Get smart with your money

Q&A

Q&A: Hard to predict tax rates

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Dear Liz: I read your column answer to the 40-year-old who asked about regular 401(k) versus Roth 401(k) contributions. Obviously, the answer has more moving parts than you have space for. However, using before-tax dollars for the 401(k) gives him a small break now, but when he hits 70 1/2, those dollars will impact the taxability of his Social Security benefits. He could contribute to the 401(k) with after-tax dollars, get the company match and avoid that impact 30 years in the future, right?

Answer: The “right” answer requires knowing what tax rates will be 30 years in the future, at a time when no one is entirely sure what tax rates will be next year. Which means the smart approach is to hedge one’s bets. Given the original reader’s current financial situation, that translates into focusing most contributions into the pretax 401(k) but also making contributions to the Roth. That will give him some flexibility to control his tax bill in retirement without going “all in” on the bet that his tax rate then will be higher than it is now.

Q&A: How student loans can follow you to the grave

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Dear Liz: Several years ago, my daughter called in tears asking if I could help because my granddaughter, who was halfway through her first year of college, would have to drop out if she didn’t immediately finish paying her tuition. I agreed to co-sign a loan, thinking after she got through that semester, they could see how things went.

Well, unbeknownst to me, she took out a loan that also covered the next semester. She dropped out of school in her second year. Now several years later, I’m being hounded by the lender because neither my granddaughter or daughter seem to think they should have to do anything about this. I sometimes get up to four calls a day, seven days a week. I have returned calls but gotten nowhere.

Meanwhile, my granddaughter recently got a brand-new car and posts pictures of herself enjoying partying with friends. I tried to get her to talk to me about it, thinking if she, along with her mom and myself, could each manage to pay a little each month we could work on getting this taken care of, but I got no response from either of them.

My daughter and son-in-law still go on cruises and do other traveling, drive newer expensive vehicles and will no longer talk to me.

I am 73 and struggling to live month-to-month on Social Security, which is my only income. I used to have an 800 credit score that has now gone down into the 600s because of this.

Now I am afraid they will start taking this out of my Social Security check. This loan is about 72% of my total annual income! My doctor has upped one of my medications as I have trouble sleeping worrying about this.

What am I to do? The only way I can see out of this would be my death, and then I’m afraid it would even follow me to my grave.

Answer: If you co-signed the loan, then it was likely made by a private lender that won’t be able to take your Social Security check. Federal student loans are a different story. The U.S. Supreme Court has ruled that up to 15% of borrowers’ Social Security benefits can be taken to repay those.

Federal student loans also have no statute of limitations, which means the government can indeed pursue you to the grave. Private student loans, however, do limit how long lenders have to sue you over the debt. The time limit varies by state and is typically three to 10 years, but the limit may be extended in some areas if you make a payment on the debt or even acknowledge that it’s yours.

You should make an appointment to talk to a bankruptcy attorney. Student loans typically can’t be erased in bankruptcy, but an attorney familiar with the credit laws in your state can advise you about how vulnerable you might be to lawsuits and other collection actions.

If Social Security is your only income and you don’t have other assets a creditor can take, you may be “judgment proof.” That means a lender can sue you, but won’t be able to collect anything.

If that’s the case, the attorney may be able to communicate the situation to the lender so that it can redirect its energies to collecting from your irresponsible granddaughter.

Q&A: Keep your ID papers current

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Dear Liz: In helping my 92-year-old father update his trust, we ran into a snag. Both his passport and driver’s license had expired.

We thought he didn’t need them since he does not travel, drive or hit the bars.

But to notarize documents, you need current identification. Getting a state ID card added many weeks to the process.

Remind your elderly readers to keep their ID current.

Answer: Consider it done.

Q&A: Debt settlement vs. filing for bankruptcy: Pros and cons

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Dear Liz: I owe a credit card company about $16,900. I have not been able to make payments for almost two years and have no money. They recently sent me a proposal to pay off the entire amount at 30 cents on the dollar by making 24 payments of a little over $200 per month. I’m concerned they can then resell the unpaid amount to a debt collector and that it really isn’t a solution for the entire debt to be extinguished, even if I agree to their proposal. Am I right?

Answer: In the past, poor record-keeping and unethical behavior meant some debt buyers routinely re-sold debts that were supposed to be settled. While that can still happen, it’s less likely, especially if you’re dealing with the original creditor or a company that’s collecting on the creditor’s behalf, rather than a company that purchased an older debt.

You’ve been offered a pretty good deal, says Michael Bovee, president of debt settlement company Consumer Recovery Network. Typically debts are settled for 40 to 50 cents on the dollar.

That doesn’t mean you should take it, necessarily. You have to be able to make the payments to get the debt settled, for one thing. Also, any debt that’s forgiven can be treated as income to you. The creditor will send you (and the IRS) a Form 1099-C showing the forgiven amount and you’ll typically owe income taxes on that amount unless you’re insolvent. If you’re in the 25% tax bracket, that would add roughly $3,000 to the cost of settling this debt.

Many people who can’t pay what they owe are better off skipping debt settlement and filing for Chapter 7 bankruptcy, which erases credit card balances, medical bills, personal loans and many other unsecured debts in three to four months. Chapter 7 typically has a bigger impact on your credit scores than debt settlement, but it legally erases the debts and prevents creditors from filing lawsuits against you. If you try to repay this debt and fail, or if you continue simply ignoring it, you could get sued.

You can get a referral to an experienced attorney from the National Assn. of Consumer Bankruptcy Attorneys at www.nacba.org. Discuss your situation and your options before you decide how to proceed.

Q&A: Your debt lives even after you die

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Dear Liz: I live in a senior building and we had a discussion about our debt after we pass away. I said, “If we have any money in our estate, that will pay it off.” One woman who lives here claims that all you have to do is send in a copy of a death certificate and that will get rid of any debt. Hope you can settle this for us.

Answer: Debt doesn’t just disappear when someone dies. Whether and what creditors get paid, though, depends on a lot of factors.

After someone dies, the executor of the estate (or the personal representative, if the deceased had a living trust) is supposed to notify creditors of the death. The first bills to be paid usually are the costs of administering the estate, followed by secured debt such as mortgages, liens and so on, then the funeral and burial expenses, says Los Angeles estate planning attorney Andrew Steenbock. Next in line typically are medical bills from the final illness and the dead person’s last tax bill. Then other creditors are paid from what’s left, if anything. Only after creditors are paid can any remaining assets be distributed according to the will, trust or state law if there are no estate planning documents. If the estate is insolvent — with more debt than assets to pay those debts — then heirs typically get nothing and the creditors are paid a portionate amount of whatever assets are available.

Things can get more complicated if there is a surviving spouse or co-signer, since debt that’s jointly owed would become the survivor’s problem.

Ignoring these rules can have serious repercussions for the executor, who can become personally liable for mistakes made in settling an estate. If your neighbor’s executor ignores state law and distributes assets to heirs before paying off creditors, for example, the creditors could sue the executor. That’s a pretty powerful incentive for learning and obeying those rules.

Q&A: Saving for retirement also means planning for the tax hit

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Dear Liz: I’m 40. We own our house and have a young daughter. Through my current employer, I’m able to contribute to a regular 401(k) and also a Roth 401(k) retirement account. My company matches 3% if we contribute a total of 6% or more of our salaries. Are there any reasons I should contribute to both my 401(k) and Roth, or should I contribute only to my Roth? My salary and bonus is around $80,000 and I have about $150,000 in my 401(k) and about $30,000 in my Roth. Thanks very much for your time.

Answer: A Roth contribution is essentially a bet that your tax rate in retirement will be the same or higher than it is currently. You’re giving up a tax break now, because Roth contributions aren’t deductible, to get one later, because Roth withdrawals in retirement are tax free.

Most retirees see their tax rates drop in retirement, so they’re better off contributing to a regular 401(k) and getting the tax deduction sooner rather than later. The exceptions tend to be wealthier people and those who are good savers. The latter can find themselves with so much in their retirement accounts that their required minimum distributions — the withdrawals people must take from most retirement accounts after they’re 70½ — push them into higher tax brackets.

That’s why many financial planners suggest their clients put money in different tax “buckets” so they’re better able to control their tax bills in retirement. Those buckets might include regular retirement savings, Roth accounts and perhaps taxable accounts as well. Roths have the added advantage of not having required minimum distributions, so unneeded money can be passed along to your daughter.

Given that you’re slightly behind on retirement savings — Fidelity Investments recommends you have three times your salary saved by age 40 — you might want to put most of your contributions into the regular 401(k) because the tax break will make it easier to save. You can hedge your bets by putting some money into the Roth 401(k), but not the majority of your contributions.