Ask Liz Weston

Get smart with your money

Q&A

Q&A: Capital gains tax on mutual funds

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Dear Liz: My mother, who is approaching 100 and in good health, has a significant mutual fund holding. It is mostly made up of capital gains. She does not need this fund for her daily living expenses. The question she has: Are the taxes on disposition the same before or after she dies? I am thinking of things like the capital gains tax exemption (never used) as well as inheritance taxes.

Answer: The capital gains tax exemption applies to the sale of a primary residence — a home, not a mutual fund. If your mother sold the fund today, she would owe capital gains tax on the difference between the sale price and her “cost basis.” Her cost basis is what she paid for the fund originally plus any reinvested dividends. The top federal capital gains tax rate is 20%, although most taxpayers pay a 15% rate.

If her objective is to get the maximum amount to her heirs and minimize the tax bill, she should bequeath this investment to them at her death. Then the mutual fund will get a “step up” in tax basis to the current market value. When the heirs sell the investment, they’ll only owe taxes on the appreciation that occurs after her death (if any).

You asked about inheritance taxes, but only a few states levy taxes on inheritors. Typically, it’s the estate that would pay the taxes, and only those above certain amounts. In 2016, the federal estate taxes exemption is $5.45 million

Q&A: Fee-only financial planners

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Dear Liz: When you recommend a “fee-only adviser,” do you mean an adviser that charges customers by the hour for advice or one that charges a percentage of the customer’s portfolio that the adviser manages?

Answer: Fee-only planners charge their clients in a number of different ways. What distinguishes them is the fact that they are only compensated by their clients; they don’t accept commissions from the products or services they recommend.

Some fee-only planners charge by the hour, which is helpful for people just starting out or those who need targeted help, such as advice on their retirement portfolios. You can get referrals to fee-only planners who charge by the hour from the Garrett Planning Network at www.garrettplanningnetwork.com.

Many fee-only planners charge a percentage of your assets that they manage or a percentage of your net worth. Another popular method is to charge a quarterly or annual retainer fee. You can get referrals to these types of planners from the National Assn. of Personal Financial Advisors at www.napfa.org.

It’s a good idea to interview a few planners to discuss what they can do for you and the expected costs before making a decision. In addition, the Financial Planning Assn. has tips on choosing a financial planner at www.plannersearch.org.

Q&A: Social Security survivor benefits

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Dear Liz: I am 63 and retired but have not started to collect my Social Security. My husband will be 67 in March. He started his Social Security at 62. Our plan is to wait until I am 70 to start my benefit, which would make my monthly amount significantly larger than his. If I predecease my husband, would he be able to collect my benefit instead of his own? If I started benefits now, our checks would be relatively close in size, although mine would be a bit higher than his current amount.

Answer: If you had started benefits already, your husband’s survivor benefit would equal what you were receiving when you died. Since you didn’t start early, though, your husband will get more.

If you should die before your full retirement age of 66 without starting retirement benefits, he would receive a survivor benefit equal to what you would have received at 66.

If you continue to delay benefits past age 66, your retirement — and thus his survivor benefit — would accrue the “delayed retirement credits” that boost your Social Security check by 8% annually between age 66 and age 70, when your benefit maxes out. In other words, if you die between 66 and 70 without starting benefits, he would get the delayed retirement credits and larger check you’d earned even if your checks hadn’t started.

As you can see, delaying the start of benefits is a great way to maximize what a survivor receives. It’s particularly important for the higher earner in a couple to put off filing for retirement benefits for as long as possible.

Q&A: Long-term capital gains tax

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Dear Liz: I’m very confused about the long-term capital gains tax. Several years ago, I bought a house for $525,000 in Texas. I’ve been thinking about selling, and my real estate agent informed me that my home is now worth $1.5 million. I am a disabled veteran and have no tax liability because my income is tax-free. Since this is my primary residence, I know that the first $250,000 in gains is exempt from tax. What I just don’t understand is what my tax liability will be on the rest of the money.

Answer: If you sell this house, you’ll essentially go from the bottom tax bracket to the top. Single people with incomes over $415,050 in 2016 are subject to the 39.6% marginal tax rate.
Most people pay capital gains tax at a 15% rate, but those in the top bracket face a 20% rate.

Improvements you’ve made to the house and some other expenses, such as selling costs, can reduce the amount of gain that’s subject to tax.

This big windfall could have other effects on your taxes, so you’ll want to consult a tax professional before proceeding.

Q&A: Paying off student loan

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Dear Liz: am going to pay off one of my daughter’s private student loans. One has a balance of $8,500 at 4% interest and the other is for $7,500 at 6%. Which one should I pay off?

Answer: You have a lucky daughter, either way.

In addition to balances and rates, the other variable you need to consider is whether the rates are fixed or adjustable. These days, many private student loans have fixed rates, but in the past most of this debt had variable rates. Variable rates mean higher costs and larger payments when interest rates rise.

If both loans have variable rates, or both are fixed, then paying off the highest rate debt first makes the most sense. If the lower rate loan is variable and the higher rate one is fixed, you’ll have to guess whether interest rates are likely to rise enough in the next few years to instead pay the larger balance first. Some people might want to pay off a variable debt just to eliminate the uncertainty, while others are willing to gamble that rates aren’t likely to jump two full percentage points before the loan is scheduled to be paid off.

Q&A: Why your W-4 forms are likely ‘wrong’

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Dear Liz: After being an unmarried couple for 15 years, we were married in February 2014. Though I sent this information to my company’s benefits department, I neglected to change my W-4 status from “single” to “married.” I’m crossing my fingers that when all is said and done, we have paid the correct taxes when we filed for 2014 (we filed jointly as married) regardless of what was withheld pursuant to the W-4. Or do I need to inform the IRS of the oversight for the 2014 and 2015 tax years?

Answer: Best wishes on your marriage, and don’t worry. Since you were married as of Dec. 31, 2014, and you filed as a married couple for 2014, you’re good — assuming, of course, you used current tax software or IRS tax tables for married filing jointly.

The W-4 form is meant to tell your employer how much of your paycheck you want withheld. Most people’s W-4s are “wrong” in the sense that they have the government withhold too much. They get fat refunds that average close to $3,000, but they aren’t penalized for doing so (other than not having access to their own money until they get that refund, of course).

If you’re getting refunds, you can tweak your withholding when you visit your benefits department to update your W-4. The IRS and TurboTax, among other sites, have online calculators to help you figure out what you should have withheld.

While you’re there, check your beneficiaries for any workplace retirement plans and life insurance. Federal law says your spouse must be the beneficiary of your retirement plan unless he or she signs a waiver. Life insurance, by contrast, goes to the named beneficiary even if you subsequently marry.