Ask Liz Weston

Get smart with your money

Q&A

Q&A: Taxes on account withdrawals

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Dear Liz: We have two large expenses that need to be paid this year. I’m in my late 60s. My wife is in her 50s. I think that we should pull the money from our brokerage account (which is taxable) and protect the money in our IRA and Roth IRA accounts so that it can continue to grow tax deferred (and tax free in the case of the Roth). My wife feels that the withdrawal should come from the IRA or Roth IRA, saying that the money used from the brokerage account would be “double taxed.” Which account would you pull the money from?

Answer: There should be no double taxation when you sell investments in a brokerage account. You pay taxes only on the growth in value of the investments you bought.

She may be confused if you’ve paid taxes in the interim on dividends and capital gains distributions. If those were paid out to you, they’re no longer part of your investment and won’t be taxed again when you sell. If the dividends and capital gains were reinvested, those amounts should be added to the original purchase price to determine your tax basis, or the amount you can deduct from the sales proceeds to determine your capital gains.

You typically benefit from favorable capital gains rates if you sell investments in a taxable brokerage account that you’ve held for at least a year. By contrast, withdrawals from traditional IRAs are typically taxed at higher income tax rates. A large enough withdrawal from a traditional IRA could throw you into a higher tax bracket. And withdrawals from either the brokerage account or the traditional IRA could increase your Medicare premiums.

Qualified withdrawals from a Roth may not affect your taxes or premiums, but as you noted you’d be giving up future tax-free compounding, which could be an even stiffer price to pay.

It also matters who owns the retirement accounts. For example, a withdrawal from your wife’s IRA could be penalized as well as taxed if she’s not yet 59½.

There are enough moving parts to this decision that you’d be smart to consult a tax pro who can model how the various transactions will affect the rest of your finances.

Q&A: How to help someone else build credit

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Dear Liz: My 30-year-old son lives in Southeast Asia. He has some U.S. bank accounts but no U.S. credit cards. If I add him to my credit card, will that help to establish credit? Or is there another way for him to start getting credit in the U.S.? At some point, he and his wife will move back to the U.S.

Answer: Adding someone to your credit card as an authorized user can be a great way to help them build credit. Your history with the card is typically added to the other person’s credit reports and used in calculating their credit scores. If you can add him to more than one card, even better. As long as you use the cards responsibly — paying the bills on time, using only a fraction of the available credit — his scores should benefit.

You don’t have to give your son access to the cards for this to work. If you do, keep in mind that authorized users aren’t responsible for paying any charges.

Authorized users typically can be added or removed with a phone call to the issuer. You also can add an authorized user online by logging into your credit card account. But removing them may require you to pick up the phone.

Your son can build credit in other ways, including credit builder loans and secured cards, but those may have to wait until he has a U.S. address.

Q&A: 401(k) payouts and Social Security

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Dear Liz: I was laid off from my job in late 2021 and at 62 was unable to find employment. After six months of unemployment benefits, I filed for Social Security. My 401(k) account from my previous employer was rolled into a traditional IRA. I also took a distribution to carry me through the months without unemployment and to repay a 401(k) loan I used as the downpayment on my home. I was taxed on the total amount of rollover funds, as well as on the distribution, which seems like I paid tax twice. All told, it looks like I made a lot of money in 2022. How will this affect my Social Security benefits going forward?

Answer: You don’t have to pay tax on the 401(k) funds that were rolled into the traditional IRA. If you’ve already done so, please consult a tax pro immediately about filing an amended return to get that money back.

You may have been confused by the 1099-R tax form issued by your 401(k) provider, which reported the entire amount that left your 401(k) account as a distribution. But only the amount that didn’t make it into the IRA is considered taxable.

The taxable distribution isn’t considered earned income that would trigger the earnings test. (The earnings test applies to people receiving Social Security before their full retirement age, currently ages 66 to 67. The test causes $1 to be withheld for every $2 earned over a certain limit, which is $21,240 in 2023.)

But distributions can cause more of your Social Security benefit to be taxable. Taxes on Social Security are based on a unique formula known as “combined income,” which includes your adjusted gross income plus any nontaxable interest and half your Social Security benefits.

If you’re a single filer and your combined income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. If your combined income is more than $34,000, up to 85% of your benefits may be taxable. Married couples filing jointly may have to pay income tax on up to 50% of benefits if their combined income is between $32,000 and $44,000. If their combined income is more than $44,000, they could owe tax on up to 85% of their benefits.

Keep in mind that you don’t lose 50% to 85% of your benefit to taxes. That’s the proportion that is subject to tax.

A tax pro can help you estimate the effect of future distributions and calculate how much you may need to withhold to avoid penalties.

Q&A: Here’s how to budget your money using the 50/30/20 rule

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Dear Liz: What is the formula now for expenses? When growing up, we were told that one-third of net income should go to rent, but recently, I read that 50% is the standard with the remaining 50% divided between wants and savings.

Answer: You may be referring to the 50/30/20 budget, which suggests limiting “must haves” to 50% of after-tax income, leaving 30% for wants and 20% for savings and extra debt payments. (After-tax income is your gross income minus taxes and is often a different figure from your net income. Your net paycheck may include deductions for insurance premiums, retirement contributions and other expenses.)

The 50/30/20 budget was popularized by Sen. Elizabeth Warren (D.-Mass.) and her daughter, Amelia Warren Tyagi, in their book, “All Your Worth: The Ultimate Lifetime Money Plan.” Warren once headed Harvard University’s Consumer Bankruptcy Project and promoted the budget as a way to help people reduce their chances of going broke.

The “must haves” category includes more than housing payments. It also includes other costs that would be difficult, expensive or dangerous to forgo temporarily, such as food, utilities, transportation, minimum loan payments and insurance.

The budgeting rule you grew up with, just like the 50/30/20 budget, was meant to help people live balanced financial lives. Limiting spending on big expenses, such as rent or mortgage payments, helps ensure there’s enough left over to save for the future, pay off the past and enjoy the present.

Of course, many people find it difficult to limit their must-have expenses to recommended levels, especially in high-cost areas. Housing costs alone can eat up half their incomes, or even more. To avoid going into debt, they may need to reduce other spending or saving or find ways to increase their income.

Q&A: They lent their friend a van. It’s getting awkward. Now what?

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Dear Liz: A friend of ours had a huge problem with car repairs last year. This friend got ripped off by a mechanic who took money for the work to repair his car and never repaired it. So my husband and I were kind enough to loan him our van for what we thought would be a short time. The loan has now lasted a year. He put a lot of repair work into it, but we need to ask for the vehicle back. It is not titled to him. I feel bad that he has spent money working on the van. Should we offer him any money or reimburse him for the work? I have a feeling it’s not going to go over very well. Any thoughts or advice on how to handle this would be appreciated.

Answer: As you probably know, the pandemic and a lingering microchip shortage have upended the car market, dramatically raising prices for both new and used cars. Interest rates have gone up as well, making car loans a lot more expensive. Your friend may well have made the calculation that repairing a borrowed vehicle made a lot more economic sense than trying to buy a replacement. He avoided lease or loan payments, plus he may have benefited from free insurance coverage if you continued to pay those premiums.

One approach would be to put a rough dollar value on those savings compared with what he spent on repairs and offer to reimburse him for the difference.

Should you ever again want to loan a potentially valuable asset to a friend, consider discussing in advance who will be responsible for maintenance and repairs as well as how long the loan is expected to last. Putting the details in writing could help both parties avoid awkward misunderstandings.

Q&A: Securities Investor Protection Corp. coverage

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Dear Liz: This is a follow-up question to your column concerning stock brokerage accounts and the coverage provided by Securities Investor Protection Corp. My husband and I are puzzled as to how the failure of a brokerage, which does not actually own our shares of stock, could cause us to lose that stock, leaving us to the limited protection the SIPC can provide. Can you explain what the sequence of events would be?

Answer: SIPC coverage kicks in when a brokerage fails and customer assets are missing. You’re correct that brokerages are required to keep customer assets separate from their own, so missing stocks and other investments would probably be due to fraud, which is rare. Most of the time when a brokerage fails, all customer assets are simply transferred to another firm.

SIPC protects up to $500,000, including a $250,000 limit for cash. Many brokerages also have private insurance in addition to SIPC coverage to protect against such losses.