Ask Liz Weston

Get smart with your money

Q&A

Uncle Sam can help with education costs

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Dear Liz: I have rental property, own my home outright, am contributing to a 401(k) and have a pension, so finances are not a big issue. I do have an adult son in law school and would like to know the most fiscally prudent way to pay for it. Are there limits on gifts, and can the money be tax deductible since it is an investment to increase his future earnings?

Answer: Interest on student loans is generally tax deductible for the person who takes out the loan if his or her income is below certain limits (the deduction begins to phase out at $50,000 adjusted gross income for single filers and $100,000 for joint filers), said Mark Luscombe, principal analyst for CCH Tax & Accounting North America.

Education tax credits also can help offset college costs. The American Opportunity Credit is limited to the first four years of college, but law school expenses could qualify for the Lifetime Learning Credit, Luscombe said. The credit starts to phase out at $53,000 of adjusted gross income for single filers and $107,000 for joint filers, he said.

If you don’t qualify for other credits and your son is under age 24, you may be able to deduct up to $4,000 in qualified education expenses if your income is below certain limits (modified adjusted gross income of $160,000 if married filing jointly or $80,000 if single), Luscombe said. You can find out the details in IRS Publication 970, Tax Benefits for Education.

Another potential tax benefit has to do with the gift tax. You can avoid the hassle of filing a gift tax return, or using up any portion of your gift tax exclusion, if you pay tuition or medical bills for someone else. You have to pay the provider directly — you can’t cut a check to the person receiving the services.

Normally, you’d have to file a gift tax return if you gave any recipient more than the gift tax exclusion limit, which is $14,000 in 2013. You wouldn’t be subject to an actual gift tax, however, until the sum of the contributions over that $14,000 limit exceeded your lifetime gift exemption. The gift exemption is currently $5.25 million, so the gift tax is an issue that few people face.

If you are that rich and generous, then you’ll probably want to discuss your situation with a qualified estate planning attorney to find the best ways to give.

Can you be too cautious about spending money?

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Dear Liz: I think I have a phobia about spending money. I’m a young professional who has devoted a lot of time to building up my savings account. I also contribute sizable amounts to my 401(k) and IRA each month. I pay off my credit cards each month, and I am making larger-than-necessary payments on my small student loans. Still, I feel as if every time I spend money on something — clothing, travel, furniture, etc. — I am undoing my hard work. It makes me scrutinize every decision until I either give up or make an impulse purchase. Is this normal? How do I know when it is OK to actually spend the money I have worked to save?

Answer: Being cautious about spending money is fine. If making purchases causes you great anxiety, though, or you’re unnecessarily compromising your quality of life, then you may want to seek help.

People with irrational fears of spending money may put off necessary doctor visits, buy unhealthy food because it’s cheap (at least in the short run), refuse to make charitable contributions or forgo pleasurable experiences. Instead of using money as a tool to live a good life, they make saving an end in itself.

Since you’re by nature a saver and a planner, you should use those strengths to free yourself from unnecessary concerns about spending money. If you enjoy travel, for example, plan a few trips and set aside money in advance to pay for them. Do the same thing with clothing or furniture upgrades. Planning and knowing how much you have to spend can help you dispel some of your anxiety and minimize the chances of regret.

Talking to a therapist or a financial planner could give you some additional strategies for dealing with your worries.

Don’t invest emergency cash

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Dear Liz: I always hear you talking about having an emergency savings fund. Most people that I’ve heard talk about this recommend keeping it in cash. I just couldn’t stand watching that money languish in a low-interest savings account, so I recently moved it over to my brokerage account and purchased a few exchange-traded funds. My wife and I are under 30 and we both have very stable jobs. We have adequate insurance (including a home warranty). We also have a $20,000 signature line of credit through our credit union in case of an emergency, in addition to multiple credit cards with high limits and no revolving balances. I feel that we are covered in case of an emergency with the credit line alone. Does all of this sound reasonable to you or should I go back to keeping my emergency fund in cash?

Answer: Lines of credit can be a reasonable substitute for an emergency fund for people who have more pressing financial goals, such as saving for retirement and paying off debt.

But there’s really nothing like cash in the bank for meeting life’s inevitable financial setbacks. Even seemingly stable jobs can be lost, and lines of credit can get used up fairly quickly. If these personal setbacks happen at the same time as a stock market downturn, your emergency fund could dwindle dramatically.

That’s why it’s best to keep emergency cash safe and accessible in an FDIC-insured bank account. You can squeeze a little extra return from the money by opting for one of the online banks that’s paying close to 1%. Trying to squeeze much more, though, increases the odds that it won’t be there when you need it the most.

Use a credit card like a debit card to avoid debt

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Dear Liz: Here’s a suggestion for the reader who prefers a debit card to a credit card so she will not get in debt: Use your credit card as a debit card. Every month I pay any credit card balance plus an additional amount equal to a month’s average purchases. Then I keep track of what I spend so I don’t go over that amount during the billing period. This is the same as paying the bill one month ahead. I don’t go into debt at all and still get my reward points.

Answer: Another way to accomplish the same end is to check your credit card balance every week and move that amount to a savings account. When the bill is due, you can move the money back to checking from savings and pay in full. It’s important in any case to stay on top of your balances and make sure you’re not spending more than you can pay off each month.

Elderly parent wants to help unemployed sons

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Dear Liz: Both of our sons, ages 63 and 59, are currently unemployed. We are 93 and self-supporting with Social Security and my retirement benefits. We live in our own home and are able to handle all our expenses, even though my wife requires a companion for 12 hours each day.

I believe we should financially aid both sons, to the limit of our ability, but my wife disagrees.

They are the two main beneficiaries of our estate. Each one is scheduled to receive about $40,000 upon our deaths. How should we proceed?

Answer: If your estates won’t amount to much more than $80,000 at your deaths, it doesn’t sound as if you have the financial wiggle room to help your sons. Your wife already requires significant care and may need more in the future. Plus, she’s likely to outlive you, which would mean getting by on less (certainly a smaller Social Security benefit, and perhaps a smaller pension amount as well). Any money you give them, in other words, is likely to be to her detriment.

Lack of savings makes becoming a landlord risky

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Dear Liz: My husband and I, both 44, own and live in one side of a duplex. The owners of the other side are moving next year and have offered to sell it to us. We don’t have enough in savings to cover a 20% down payment for a traditional mortgage, but our neighbors offered to do owner financing. Rentals are hot commodities in our area, and we’ve been told by real estate agents that they could get the place rented within a week for more than we’d make in mortgage payments. This would be an amazing opportunity for us, but if for some reason the property went vacant we couldn’t cover the payment unless we make some major changes to our budget, such as selling our RV ($325 a month) or temporarily suspending contributions to our 457 deferred compensation plans (we contribute $300 a month and both our jobs come with pensions that will replace 60% of our salaries). We currently also make a truck payment ($350 a month) and have $2,300 in credit card debt, but we only have $1,000 in accessible savings.

Answer: You’re not in a great position to be landlords. You have too little savings to cover the inevitable repairs and vacancies you’ll face. Plus, your credit card and vehicle debts indicate you’ve been living beyond your means.

Still, this may be a promising opportunity. A rental that is cash-flow positive — in which the rent collected exceeds the cost of the mortgage, property taxes and insurance — can be a decent long-term investment. If you’re willing to commit to improving your finances and taking this risk, it could work out.

Talk to some other landlords first to see what challenges they face and what typical vacancy rates they experience. You’ll want to locate a lawyer who understands your state’s landlord-tenant laws to draw up any paperwork you’ll need.

If you decide to proceed, sell the RV and use whatever’s left after paying off the loan to pay down your credit card debt. Then redirect the RV payment to paying off the rest of the cards and building up your savings. (A note for the future: RVs are fun, but they’re luxuries, and luxuries should be paid for in cash.)

Don’t compromise your retirement savings. Your generous pension could get whittled down in the future, or you might lose those jobs. Having a decent retirement kitty of your own is simply prudent.