Ask Liz Weston

Get smart with your money

Q&A

Stick to an investment plan for best results

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Dear Liz: If I plan to stay invested for more than 15 years and I can tolerate the ups and downs of the market, why would I want to put any of my 401(k) money into bonds instead of putting it all in various stock funds? The bond funds in my 401(k) have a five-year return of 5% to 6% whereas the other funds are 8% to 13%.

Answer: If you look at the more recent performance of those bond funds, you’ll notice that their returns are considerably worse. Many have been losing money lately as interest rates have risen. That poor performance may worsen if the economy improves and rates continue to rise.

But you need to consider more than recent performance when allocating your portfolio. Bonds and cash can cushion your account against big downturns in the stock market. That can help keep you from panicking and selling at a bottom.

If you’re as risk tolerant as you think and decades away from retirement, you might be able to put as little as 10% of your portfolio into bonds and cash. If you’re 15 to 20 years from retirement, a 20% bond allocation may be more prudent. A fee-only financial planner can help advise you about sensible asset allocations, or you can check out the stock and bond mixes of target date funds offered by leading mutual fund companies (such as the Vanguard Target Retirement 2030 Fund, if you’ll be retiring around 2030).

Will credit scores be helped by faster loan paydown?

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Dear Liz: I had a 730 credit score and went shopping for a car. The inquiries on my credit report took my score down to 704. Now that I have the auto loan, does it help my score to make larger payments and reduce the principal faster? The payment is currently $375 but I could pay $500 a month if this is advantageous.

Answer: It’s unlikely the auto loan inquiries lowered your credit score by that much. An inquiry typically dings your scores by less than five points. Even if the dealership queried several lenders on your behalf, all the auto loan inquiries typically would be combined and counted as one. What’s far more likely is that other information on your credit report changed, affecting your score. A higher balance on a single credit card could have that effect.

By the way, you don’t have one credit score, you have many. Each credit bureau sells different versions of the FICO score to lenders, and auto lenders typically use a version of the FICO tweaked for their industry. It’s possible your lender used just one of these FICO scores to evaluate you, but others might use three — one from each bureau. Also, if you’re monitoring your score using a free service or one sold by a bureau, the number you’re seeing might not be a FICO at all but some alternate credit score that lenders don’t typically use.

To answer your question: Reducing the balance on an installment loan, such as a car loan or mortgage, would help your scores, but not nearly as much as paying down revolving accounts, such as credit cards. If you have any credit card debt, you’d be far better off using your extra money to pay off those bills. Not only would doing so help your scores more, but it also would have a bigger effect on your finances, since credit card interest is typically far higher than that charged on an auto loan.

Son signed them up for overwhelming student loan debt

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Dear Liz: Our son went to an expensive private school and ended up with more than $100,000 in federal and private loans by the time he graduated. My wife cosigned a private loan for $25,000 for the first year, and that was the last we heard of any loans until he graduated with a degree in social services. After he was out of school for six months, we started getting phone calls asking for payment. Turns out he electronically signed my wife’s name to the next three years of his student loans.

Just to keep the creditors from harassing us daily, we pay the interest, which is about $1,100 a month and equals two-thirds of my wife’s take-home pay. (I’m disabled and can’t work; she’s 64 and planning to retire soon.) Our son hasn’t paid a dime on any of the debt and seems to think it will disappear if you don’t talk about it. He makes only $15 an hour. He still takes college classes and he thinks that because he is in school, he doesn’t need to pay anything. But the interest is still accruing monthly.

After my wife retires, how much of our Social Security checks can they come after? Can they come after our house? We will be living on Social Security only as we were never fortunate enough to have employers who offered pension plans. I sometimes feel that we will have no real retirement because of this situation. Any suggestions and advice would be appreciated.

Answer: What a mess. If nothing else, your situation can serve as a warning to other families tempted to buy educations they can’t afford. Taking on six-figure debt for an undergraduate degree, let alone one in social services, is nuts. Generally, students shouldn’t borrow more in total than they expect to earn the first year out of school. Also, most people should stick to federal student loans. Using private loans to pay for college is a lot like using credit cards, although unlike credit card debt, these variable-rate loans typically can’t be discharged in bankruptcy.

It’s not clear whether your son committed identity theft in signing your wife up for additional debt. Some private loans include a clause permitting the origination of subsequent years’ loans in addition to the original loan, said Mark Kantrowitz, publisher of Edvisors Network. You’d have to review the promissory note to see if that’s the case. If not and if your son forged your wife’s signature, she potentially could get released from the obligation — but most lenders will require the son to be convicted of identity theft first, Kantrowitz said.

“When given that choice,” he said, “most families choose to handle it internally rather than see the student convicted of fraud.”

The only good news here is that private student lenders have fewer powers to collect, compared with the federal government. There is a time limit on how long collectors can pursue you because private student loans are subject to each state’s statute of limitations on debt. (There is no statute of limitations on federal student loan debt, which means collectors can pursue borrowers indefinitely.) Private student lenders can file lawsuits against you, but they don’t have the power that federal student loan collectors have to withhold tax refunds and take a portion of Social Security checks.

If your only income in retirement is from Social Security and you don’t have any other property a creditor can legally take, you may be “judgment proof.” That doesn’t mean you can’t be sued, but a creditor wouldn’t be able to collect on a judgment against you. To find out whether that’s the case, talk to an experienced bankruptcy attorney familiar with the laws in your state.

None of this reduces your son’s responsibility for his debt. If collectors can’t come after you, they will start to pursue him in earnest for payment and he’ll learn just how wrong he is about student loan debt. But that’s his problem, and he at least has a working lifetime ahead of him to pay back what he borrowed.

Divorced retiree entitled to spousal Social Security benefits

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Dear Liz: My daughter, 63, has been recently amicably divorced and receives a small alimony ($1,000). Her ex-husband of 30 years is a doctor who just retired. Is she entitled to part of his Social Security? Neither has remarried.

Answer: Because they were married for more than 10 years, your daughter should qualify for spousal benefits, which can equal up to half of her ex’s benefit at his full retirement age. That amount would be permanently discounted if she applies before her own full retirement age (which is 66).

The ex’s marital status doesn’t matter, although your daughter’s does. If she remarries, she will lose access to spousal benefits as a divorced spouse. This is just one of the ways that spousal benefits differ from survivor’s benefits, which are based on 100% of the earner’s benefit and which widows and widowers can receive even if they remarry after age 60.

Don’t rush to pay taxes

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Dear Liz: I am a CPA and fairly knowledgeable about investing, but I have a question about my IRAs. I am 58 and my husband is in his mid-80s. We both are retired with federal pensions and no debt other than a mortgage. My plan is to start taking money annually from my traditional IRA in two or three years. I want to reduce the required minimum distribution I will need to start taking at age 701/2 and lessen the tax impact at that time. Should I put these annual withdrawals in my regular investment account or should I put them in the Roth IRA? My goal is to lessen the tax impact on my only child when he ultimately inherits this money. Does my plan make sense?

Answer: Your letter is proof that our tax code is too complex if it can stymie even a CPA. Still, it’s hard to imagine any scenario where you’d be better off accelerating withdrawals from an IRA and putting them in a taxable account.

A required minimum distribution “is merely a requirement to take the money out anyway,” said Certified Financial Planner Michael Kitces, an expert in taxation. “All you’re doing by taking money out early to ‘avoid’ an RMD [required minimum distribution] is voluntarily inflicting an even more severe and earlier RMD on yourself.”

In other words, you’d be giving up future tax-advantaged growth of your money for no good reason.

What might make sense, in some circumstances, is moving the money to a Roth. You can’t make contributions to a Roth if you’re not working, because Roths require contributions be made from “earned income.” What you can do is convert your traditional IRA to a Roth, either all at once or over time. You have to pay taxes on amounts you convert, but then the money can grow tax-free inside the Roth and doesn’t have to be withdrawn again during your lifetime, since Roths don’t have required minimum distributions. Whether you should convert depends on a number of factors, including your current and future tax rates and those of your child.

“In other words, if your tax rate is 25% and your child’s is 15%, just let them inherit the [traditional IRA] account and pay the lower tax burden,” said Kitces, who has blogged about the Roth vs. traditional IRA decision at http://www.kitces.com. “In reverse, though, if the parents’ tax rate is lower … then yes, it’s absolutely better to convert at the parents’ rates than the child’s. In either scenario, the fundamental goal remains the same — get the money out when the tax rate is lowest.”

If you do decide to convert, remember that the conversion itself could put you in a higher tax bracket.

“It will be important not to convert so much that it drives up the tax rate to the point where it defeats the value in the first place,” Kitces said. “Which means the optimal strategy, if it’s to convert anything at all, will be to do partial Roth conversions to fill lower tax brackets but avoid being pushed into the upper ones.”