Q&A

Q&A: Paying off home loan with a windfall

May 18, 2014 By Liz Weston

Dear Liz: I’m 65 and my wife is 62. We recently sold a business for over $900,000 and will net somewhere between $550,000 and $600,000. Should we use the proceeds to pay off our mortgage? Our home is worth about $1.5 million with a mortgage of $390,000 at 3.586%. We contribute an extra $200 per month to reduce the principal. We have no other debt. Our savings, retirement and brokerage accounts total $1.2 million. My wife receives a pension of $483 a month and works part time as a substitute teacher. I plan to continue working until age 70 with a salary of about $170,000 per year. On retirement we should receive about $4,400 per month in Social Security benefits.

Answer: Many people feel more comfortable having their mortgages paid off by the time they reach retirement age — even when the interest rates on the loans are so low they’d almost certainly get better returns elsewhere. (The after-tax cost of your mortgage is likely less than the longtime inflation rate of about 3%.) Not having a mortgage payment can substantially reduce your monthly expenses, which means you have to take less from your retirement accounts. Such withdrawals often trigger taxes, so you essentially save twice.

Other people feel perfectly comfortable carrying a mortgage into retirement. They’re happy to take advantage of extraordinarily cheap interest rates and keep themselves more liquid by deploying their savings elsewhere. And many people have to carry debt because they can’t pay it off before they retire, or paying off the mortgage would eat up too much of their available funds.

Because you do have choices, discuss them with a fee-only financial planner. If you pay off the mortgage and invest what’s left, you could draw about $50,000 from your retirement funds the first year without a huge risk of running out of money. That plus your Social Security and your wife’s pension may give you enough to live on. If not, you may want to invest your windfall and continue paying the mortgage down over time.

Q&A: How long do unpaid accounts and judgments remain on credit reports?

May 18, 2014 By Liz Weston

Dear Liz: My credit reports don’t show any of my old unpaid collection accounts. I also have one judgment that is not showing from 2005. My wife (who has perfect credit) and I are looking to apply for a mortgage. What will the lender find? I recently applied for a credit card to start rebuilding my credit. The issuer approved me for a card with a $1,000 limit and told me my score was in the high 700s. I am so confused.

Answer: If your collection accounts are older than seven years, your lender shouldn’t see them when it reviews your credit reports. Most negative marks have to be dropped from reports seven years and six months after the date the account first went delinquent. Civil judgments also have to be dropped after seven years unless your state has a longer statute of limitations; in that case, the judgment can be reported until the statute expires. California’s statute of limitations for judgments is 10 years.

If none of those negative marks shows on your reports and you’ve handled credit responsibly since then, your credit scores (you have more than one) may well be excellent.

Since you’ll be in the market for a major loan, you and your wife should get your FICO scores from MyFico.com. Mortgage lenders will look at all six scores (one from each of the three credit bureaus for you and your wife), basing your rate and terms on the lower of the two middle scores. If that score is 740 or above, you should get the best rate and terms the lender offers.

Your FICO scores will cost $20 each, which is a bit of an investment. You can get free scores from various online sites, but those aren’t the FICO scores that mortgage lenders use and are of limited help in understanding what rate and terms you’re likely to get.

Q&A: An Update

May 12, 2014 By Liz Weston

Dear Liz: I think you were way too hard on the young man who said his 30-year-old girlfriend’s lack of retirement savings was a potential deal breaker. You told him to get off his high horse. He was just being prudent.

Answer: It would be prudent to regard massive debt, alcoholism or drug use as deal breakers for a relationship. Elevating the young woman’s lack of retirement savings to this level is just over the top. But let’s hear what the young man himself had to say:

Dear Liz: I want to say thank you for taking the time to write on my question. I was able to find a few charts online and show her [the power of compounded returns]. She got excited about it and is now putting in to get the company match (5%).

Thank you very much for putting me in my place. I did not mean to come across as if I was better. I have been very lucky to have been able to save and be taught about compounding at an early age.

Answer: One of the potential hazards of being good with money is arrogance. We can become convinced that we know better and that other people should do things our way. It takes some humility to understand that not everyone has had the advantages we’ve had or been able to take in the information as we’ve done. Understanding that makes it easier to find compromises in a relationship that work for both parties.
Good luck with your relationship. She sounds like a keeper.

Q&A: Social Security Payouts

May 12, 2014 By Liz Weston

Dear Liz: My wife and I, 63 and 62, plan to continue working till at least 65. We will begin collecting Social Security benefits in September. Our combined income is $58,000, we own our home outright, and we have no debt, no children, $84,000 in a traditional IRA and $90,000 in a stock portfolio.

I just sold a portion of a mutual fund for a $30,000 gain that is in the bank for the time being. How long do we have to reinvest without paying a capital gains tax? Or would it be best to pay the tax now, leave the money in the bank and be done with it?

Answer: Unless you sell another investment for a $30,000 loss to offset the gain, you’re going to have to pay taxes on your profit.

“There is no way to do a tax-free reinvestment,” said tax professional Eva Rosenberg, an enrolled agent who runs the TaxMama.com site. “And the time to ask questions like that is before you sell the mutual funds.”

You still have time to avoid a much bigger mistake: signing up for Social Security now.

Your Social Security checks would be reduced $1 for every $2 you earn over a certain level, which this year is $15,480. That “earnings test” applies until you reach your full retirement age (which is 66, not 65, for both you and your wife). What’s more, you would lock in lower benefits for life and give up a chance to boost your Social Security payout in a way that’s available only to married couples who wait until full retirement age to start benefits. (More on that in a moment.)

Your savings are too small to generate much income, particularly if you want to minimize the chances of running out of money. You should be looking to maximize your Social Security benefits to help make up for that deficit. Your benefits grow substantially each year you put off applying for them, and most people will live past the break-even point where delaying benefits until full retirement age results in more money than taking them early.

Many people erroneously think they should grab Social Security as early as they can, but the Social Security system isn’t going away, and you are likely to regret settling for a smaller check. Remember that your wife probably will outlive you and will have to get by on one check, so you should make sure your benefits are as big as they can be.

One way to do that is for the lower-earning spouse to claim spousal benefits at his or her full retirement age. Once the lower earner’s benefit maxes out at age 70, he or she can switch if that benefit is larger.

But spousal benefits can’t start until the higher earner files for his or her own benefit. If the higher earner waits until full retirement age to apply, he or she has the option to “file and suspend” — a maneuver that lets the spouse claim spousal benefits while leaving the higher earner’s benefit untouched so it can continue to grow.

This “claim now, claim more later” strategy is available only to people who wait until their full retirement age to start.

Your tax question and your plan to start Social Security early indicate you could really use some sessions with a fee-only financial planner. Such a consultation is a good idea for everyone as they’re approaching retirement, but in your case, it’s essential.

Q&A: Inheritances

May 5, 2014 By Liz Weston

Dear Liz: You’ve been writing about people who expect inheritances they don’t get. Here’s another situation. My elderly dad thought he’d tied up everything in a trust, but his surviving elderly second spouse regularly invaded the principal instead of just receiving the interest. She would simply call her broker and ask for whatever she wanted. The broker, not being a knowledgeable trust officer, would send her the money. Finally, to soothe a fretting sibling, my husband and I paid for an estate lawyer to move the trust from Stepmom’s broker to a good third-party trust institution. It took more than a year plus paying a fee (OK, a bribe) for Stepmom to relinquish her direct access to the trust. She continued to receive the interest and was quite well off. She never did understand why we thought she was doing something wrong.

Answer: People set up trusts for a variety of reasons, but the type you’re describing is usually used to preserve an inheritance for the children while allowing the surviving spouse to live off the income. These trusts typically allow the survivor to tap the principal for certain purposes (“health, education, maintenance and support” is the usual phrase used). A trustee who’s asleep at the switch may allow the spouse to dig too deep, which not only reduces the children’s inheritance but also endangers the whole structure of the trust, which is designed to save future estate taxes. Your investment in hiring a competent trustee could save a lot of expense and hassle in the long run.