Ask Liz Weston

Get smart with your money

Q&A

Strategic bill paying

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Dear Liz: We received $100,000 from the sale of some undeveloped land. We are trying to figure out the best way to pay off our bills. Our primary residence has a balance of $173,000 at 4.25% and is a 30-year loan. We also own a home we rent out in which we cover the mortgage with the rent income. The balance on it is $131,500 at 4.5% for a 20-year loan. This home is often a burden when tenants change on an average of every 1 to 2 years, and we don’t have the income to cover the mortgage without the rental income. My husband took a $20,000 loan out of his retirement fund for closing costs for our primary residence, a debt that is being paid back through paycheck deductions. We also have an auto loan with a balance of $7,800 at 2.74% and credit cards with varying interest rates with total owing of $22,000. What should we do?

Answer: Your first task should be examining your spending habits to see why you have so much credit card debt. If you don’t fix the problem that’s causing you to live beyond your means, you’re likely to find yourself in a deeper hole eventually, regardless of how well you deploy this windfall.

You also should see if you’re on track with retirement savings. Boosting your retirement plan contributions at work and to individual retirement accounts can help you convert this money into long-term economic security.

Next, pay off the credit card debt and consider retiring the retirement plan loan. If your husband lost his job and couldn’t repay the debt, the outstanding balance would become a withdrawal that would incur income taxes and penalties.

Any money that’s left over can go into an emergency fund to protect against job loss and to keep you from going into debt between tenants. Your low-rate car loans and tax-advantaged mortgage debt aren’t top priorities for repayment, but you can start paying them down over time once your other bases are covered.

Should you hide assets to get more financial aid?

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Dear Liz: We have a son who is a high school junior and who is planning on going to college. We met with a college financial planner who suggest we put money in a whole life insurance policy as a way to help get more financial aid. Is that a good idea?

Answer: Your “college financial planner” is actually an insurance salesperson who hopes to make a big commission by talking you into an expensive policy you probably don’t need.

The salesperson is correct that buying a cash-value life insurance policy is one way to hide assets from college financial planning formulas. Some would question the ethics of trying to look poorer to get more aid, but the bottom line is that for most families, there are better ways to get an affordable education.

First, you should understand that assets owned by parents get favorable treatment in financial aid formulas. Some assets, such as retirement accounts and home equity, aren’t counted at all by the Free Application for Federal Student Aid or FAFSA. Parents also get to exempt a certain amount of assets based on their age. The closer the parents are to retirement, the greater the amount of non-retirement assets they’re able to shield.

Consider using the “expected family contribution calculator” at FinAid.org and the net cost calculators posted on the Web sites of the colleges your son is considering. Do the calculations with and without the money you’re trying to hide to see what difference the money really makes.

Most families don’t have enough “countable” assets to worry about their effect on financial aid formulas, said college aid expert Lynn O’Shaughnessy, author of “The College Solution.” Those that do have substantial assets have several options to reduce their potential impact, including spending down any custodial accounts, paying off debt and maxing out retirement plan contributions in the years before applying for college.

Another thing to consider is that most financial aid these days comes as loans that need to be repaid, rather than as scholarships or grants that don’t. So boosting your financial aid eligibility could just mean getting into more debt.

Meanwhile, it’s generally not a good idea to buy life insurance if you don’t need life insurance. The policy could wind up costing you a lot more than you’d save on financial aid.

If you’re still considering this policy, run the scheme past a fee-only financial planner—one who doesn’t stand to benefit financially from the investment—for an objective second opinion.

Ways to reduce tax burden

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Dear Liz: My husband and I have worked very hard and paid off our mortgage and all other debt. However, we find ourselves with no deductions now and are getting killed on income taxes. What can we do to lower our tax burden without incurring mortgage or student loan debt, child-care expenses and so on? We are in about a 33% tax bracket and it seems like we are being punished for being frugal and responsible.

Answer: There’s an old saying, “Don’t let the tail wag the dog.” Incurring expenses just to get a tax break is usually absurd. When you were paying mortgage interest, for example, your tax break was only a fraction of what you paid out. In essence, you were getting about 33 cents back for every dollar you spent in interest.

Better ways to reduce your tax burden may include maxing out retirement plan contributions, taking advantage of flexible spending accounts if your employer offers them and installing alternative energy equipment in your home. (The credit for installing solar panels and similar systems equals just 30% of the cost, but the long-term energy savings may offset the rest of the bill.) If you own a business, consult with a tax pro about the many ways to cut your tax bill when you’re self-employed.

Just remember that you’re not being punished for your frugality. Your reward is more money in your pocket year-round.

Retiree can’t get home equity loan

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Dear Liz: I retired last year. I am 67, have more than $1 million in my retirement accounts, $80,000 in individual stocks, $50,000 in cash and more than $200,000 in equity in my home. I don’t need to tap my Social Security benefit yet and can afford to wait until I am 70 to get the maximum monthly amount. I recently purchased a new car with a 0% loan for five years. That and my mortgage are the extent of my debt. One thing I would like to do is some home improvement. My fee-only financial planner suggested getting a home equity line of credit to cover the repairs and upgrades. This makes sense to me in that it spreads out the burden over time and is tax-deductible. My credit scores are 736, 801 and 839. But I’m finding it difficult to get a commitment from either my credit union or my bank because they don’t see an income. I have been with both of these institutions for more than 30 years and the credit union holds the first mortgage. How do we get the lenders to factor retirement assets into the qualification calculations?

Answer: Last year, mortgage giants Fannie Mae and Freddie Mac issued guidelines on retirement fund annuitization that would allow mortgage lenders to calculate a borrower’s income based on his or her retirement assets.

Lenders, however, have to be willing to go to a little extra effort to learn the rules and apply them properly.

If yours aren’t willing to do so, then it might be time to take your business elsewhere. A mortgage broker (referrals from http://www.namb.org) may be able to connect you with a lender who’s more up to date.

Deceased dad’s rock triggers bitter family fight

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Dear Liz: We are settling my dad’s estate. My dad found a rock, and it sat in my parents’ frontyard for years. He worked in a gravel pit for decades, and that was the only rock he found interesting enough to bring home. When my mom died, we held an auction of their household goods. My dad told me to take the rock home. I said that to be fair, the rock should be sold at auction. A family member then stole the rock and has been hiding it for more than two years. This person says it’s going to be placed on my dad’s grave site. I’m an executor, and I feel that the decision wasn’t the relative’s to make. It’s the only possession of Dad’s that I really want as a remembrance of him. We were extremely close. Dad knew the rock was taken to spite me, and it really bothered him. What are your thoughts?

Answer: Many of the items that trigger bitter family fights after a death don’t have much fair market value. Family members imbue these objects with sentimental value and then go to war over them. They might insist it’s the only thing they really want, or that they want it for their kids. Some go so far as to destroy their relationships with their loved ones to gain control of the supposed heirloom. (Which, often as not, winds up in the next generation’s yard sale, as appraiser Julie Hall once noted.)

Maybe this relative did swipe the rock to spite you. Maybe this is just the latest chapter in a drama that’s been playing out since childhood: “Dad always liked you better!” Maybe you’re especially chafed that your relative took advantage of your attempt to be fair.

But again, the rock probably has only the value you give it. If you decide it’s not worth fighting for, then it’s just a rock.

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Don’t obsess about Social Security “breakeven”

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Dear Liz: I read your recent article in which you advised waiting before starting Social Security benefits. Is this good advice for everyone? You probably know that there is a break-even age around 85, so that if you die before 85, starting benefits early is better, but if you die after 85, starting late is better. “Better” means you receive more money. So, right off the bat the advice to delay is wrong for half the people in their 60s, since about half will die before the crossover, and if they had delayed, they lost money.

Answer: The problem with do-it-yourself financial planning is that people often focus their attention too narrowly and ignore the bigger picture. That’s what leads them to do things like pay down relatively low-rate student loan debt while failing to save for retirement. They may focus only on the expected returns of each option, while ignoring the tax implications, company retirement matches and the extraordinary value of future compounding of returns.

Obsessing about the break-even point — the date when the income from larger, delayed retirement benefits outweighs what you’d get from starting early — is often a mistake, financial planners will tell you. There are a number of other considerations, including the value of Social Security benefits as longevity insurance. If you live longer than you expect, a bigger Social Security check can be enormously helpful later in life when your other assets may be spent. Also, if you have a spouse who may be dependent on your benefit as a survivor, delaying retirement benefits to increase your checks will reduce the blow when she has to live on just one check (yours) instead of two (yours and her spousal benefit).

In his book “Social Security for Dummies,” author Jonathan Peterson offers a guide to figuring out your break-even point based just on the dollars you can expect to receive (rather than on assumed inflation or investment returns). In general, the break-even point is about age 78. That means those who live longer would be better off waiting until full retirement age, currently 66, than if they started early at age 62.

Currently, U.S. men at age 65 can expect to live to nearly 83, and the life expectancy for U.S. women at age 65 is over 85.

You can change that break-even by making assumptions about inflation and your future prowess as an investor, but remember that the increase in benefits you get each year by delaying retirement between age 62 and 66 is about 7%. It’s 8% for delaying between age 66 and age 70, when your benefit maxes out. Those are guaranteed returns, and there’s no “safe return” anywhere close to that in today’s environment.

Don’t forget that those benefits will be further compounded by cost-of-living increases. One researcher published in the Journal of Financial Planning found that an investor would have to achieve a rate of return that exceeds inflation by 5% to justify taking benefits at 62 rather than at full retirement age.

“At higher inflation rates and/or higher marginal tax rates, the rate of return may need to be even higher, perhaps in excess of 7% or 8% above inflation to justify taking benefits at age 62,” wrote Doug Lemons, a certified financial planner who retired from the Social Security Administration after 36 years.

You can read Lemons’ paper, as well as other research that planners have done on maximizing Social Security benefits, at http://www.fpanet.org/journal.