Ask Liz Weston

Get smart with your money

Q&A

Q&A: Why you might want a Roth IRA

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Dear Liz: I never understood Roth IRAs. They don’t offer a tax break for contributions, so they cause you to pay taxes on your money when you’re working and in a higher tax bracket. With a regular IRA, you get a tax break upfront when you’re in the higher tax bracket and then you pay taxes on withdrawals when you’re retired and in a lower tax bracket. What am I missing?

Answer: Not everyone will be in a lower tax bracket in retirement. Some will be in the same bracket or a higher one when it’s time to withdraw the money. People in their 20s, for example, may be in the lowest tax bracket they’ll ever see. People who expect tax rates in general to rise also may wish to hedge their bets by having at least some money in a Roth.

A Roth also can make more sense if you don’t get a tax break for your IRA contributions. That could be the case if you have access to a workplace plan and your income is above certain limits, or if your income is so low that you owe little or no income tax.

Roth IRAs have a few other advantages. Having a pot of tax-free money in retirement can give you some flexibility in managing your tax bill. If a big bill comes up, for example, a withdrawal from your IRA could push you into a higher tax bracket while a withdrawal from your Roth would not.

Roths also don’t require you to take withdrawals in retirement, unlike regular IRAs. You can hang on to the money until you need it, perhaps to pay for late-in-life costs such as long-term care, or you can pass it on to your heirs.

Roths are more flexible in another way: You can always withdraw the amount you contributed to a Roth without tax consequences. Withdrawals from IRAs before retirement typically incur both taxes and penalties.

Q&A: This guy still sends checks through the mail. How that could mess up his credit score

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Dear Liz: My husband has a lower credit score than I. He gives me a check every month from his personal checking account, which I deposit in our family account so I can pay our credit cards. He thinks that he needs to pay some of the cards directly in order to improve his score. He likes to send checks by mail, the old fashioned way (which drives me crazy!). Do you think this practice will improve his score?

Answer: The short answer is no. Credit scoring formulas don’t care who pays the bills, as long as the bills get paid on time.

Perhaps explaining some credit scoring basics would help.

People don’t have one credit score. They have many, because there are many different scoring formulas in use.

The most commonly used credit score is currently the FICO 8. There are many other versions of the FICO scoring formula, including some that are tweaked for different industries such as credit cards and auto loans. In addition, there are VantageScores, a rival formula created by the three major credit bureaus: Equifax, Experian and TransUnion.

Credit scores are based on the information in your credit reports at those bureaus, which are private companies that typically don’t share information. Because information can vary from bureau to bureau, your credit scores from each bureau may differ as well.

There’s no such thing as a joint credit report or a joint credit score, so couples typically will have different scores even if they have some joint accounts. How long a person has had credit, how many credit accounts the person has and the mix of credit types can be different, resulting in different scores.

Your husband may have lower scores than yours currently, but that’s not in itself a problem that needs to be fixed. If his scores are generally above 760 on the typical 300-to-850 scale, he’ll get the best rate and terms when applying for credit.

If his scores need improving, he should start by checking his credit reports from each of the three bureaus at www.annualcreditreport.com. (These reports used to be free just once a year, but you can now get them for free every week until April 2022.) He should dispute any information that’s inaccurate such as accounts that aren’t his or accounts showing missed payments if all payments were made on time.

He may be able to improve his scores by lowering how much of his available credit he’s using or adding an account or two. Opening accounts may temporarily ding his scores, but typically the new account will add points over time if used responsibly.

And do try to persuade him to stop sending checks in the mail. A check that goes astray can result in a missed payment that can knock 100 points or more off credit scores. Electronic payments are far more secure and efficient.

Q&A: Is it time to rethink college savings?

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Dear Liz: My wife and I have three kids ages 4 and younger. We have been diligently saving in our state’s 529 college savings plans for all of them. Now with various concepts of free college and student debt relief gaining traction, I’m wondering if we would be better off simply investing future amounts elsewhere that don’t lock it into educational expenses, which may look very different in 14 to 18 years.

Answer: Politics is the art of the possible. Although some student debt relief is possible, as is some expansion of free college options, it’s hard to imagine a U.S. where college educations are entirely free for everyone.
Even in states that currently offer free two- or four-year public college options, the aid is typically limited to free tuition, which means students still have to pay for books, housing, meals, transportation and other costs. Some programs are need based, which means not all students qualify, and many students choose other non-free options, such as private colleges and graduate school.

So the advice hasn’t changed: If you can save for college, you probably should. You may not be able to cover all the costs of your children’s future education, but anything you save will probably reduce their future debt.
In an uncertain world, 529 college savings plans offer a lot of flexibility. The money can be used tax free for a variety of college expenses, and any unused funds can be transferred to a family member — including yourself or your wife, should either of you want to pursue more education. If you withdraw the money for non-education purposes, only the earnings portion is typically subject to income taxes and the 10% federal penalty.

Q&A: What to consider before taking a lump sum

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Dear Liz: I had a pension from a previous employer that was going to pay me $759 per month at 65. They offered me a lump-sum buyout about five years ago of around $65,000. I ran the numbers and decided that was definitely not enough money and declined.

Then last year they upped the offer and the new lump sum amount was $125,000. I ran the numbers again and this time decided to grab the money and roll it into an IRA. I’m 63 and plan to retire at 70. I can hopefully grow that $125,000 to $250,000 by that time, which would give me that much more to live on, plus it gives me more discretion on using that money than just getting the monthly payment the pension would have paid me.

After reading one of your latest columns, I am now questioning whether I made the right decision to take the lump sum.

Answer: There are a number of good reasons for opting for a lump sum versus an annuity. For example, people with large pensions may not be fully protected by the Pension Benefit Guaranty Corp. if their pension fund fails. Others may need more flexibility than an annuity offers.
But a pension is typically money that’s guaranteed for life, in good markets and bad. If you’re choosing the lump sum just because you think you can earn better returns, you need to consider how you’ll protect yourself and your spouse from fraud, bad decisions and bad markets.

Bull markets can lull people into thinking they’re good investors, but markets can go down and stay down for extended periods. That poses a special risk to retirees, who are at increased risk of running out of money when they draw from a shrinking pool of investments. Even a short bear market can cause problems, while an extended one can be disastrous.

You’ll also want to consider how you’ll manage when your cognitive abilities begin to decline. Our financial decision-making abilities peak in our 50s, but our confidence in our abilities tends to remain high even as our cognition slips. That can lead to bad investment decisions and increased vulnerability to fraud.

Finally, consider your spouse. If you die first, will your spouse be comfortable managing these investments? If not, is there someone in place who can help?

A fee-only financial planner could discuss these issues with you and help you create a plan to deal with them.

Q&A: Protecting home sales proceeds from taxes

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Dear Liz: My friend has been diagnosed with Alzheimer’s and is now living in a secure assisted living facility. After a year in this home, his sister finally sold his condo. Her tax person says he will take a big tax hit. I say it is totally medically ordered and he’ll need the money for his current housing ($5,000 a month) until he dies. I also question whether part of that $5,000 should be deductible because it is only ordered because of his illness. Your thoughts?

Answer: Your friend may not be able to protect all of his home sale proceeds from taxation, but he likely will be able to protect some.

If your friend lived in his condo for at least two of the previous five years before the sale, he will be able to avoid tax on up to $250,000 of home sale profits. Even if he fell short of the two-year mark, he likely would benefit from IRS rules that allow partial exemptions when the sale is due to “unforeseen circumstances.”

Meanwhile, medical expenses, including some long-term care expenses, are potentially deductible if they exceed 7.5% of someone’s adjusted gross income. Assisted living expenses may qualify as deductible medical expenses if the resident is considered chronically ill, which means they cannot perform at least two activities of daily living (eating, toileting, bathing, dressing, getting in and out of bed and remaining continent) or they require supervision because of cognitive impairment, such as Alzheimer’s disease or other forms of dementia. The personal care services must be provided according to a plan of care prescribed by a licensed healthcare provider. Typically, assisted living facilities prepare such care plans for their residents.

Q&A: A 401(k) versus an IRA: Which one wins this smackdown?

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Dear Liz: I am a 27-year-old with a big investment question. The company I work for matches 401(k) contributions up to 9%, which is all well and fine since I contribute enough to receive the company match. I have just about $60,000 in my 401(k) and I have a Roth IRA on the side as well as a brokerage account for stocks. I would like to roll over my 401(k) into another IRA since the investment choices in the 401(k) are rather limited. I’m a big fan of investment diversification with different funds. Is this a good option to choose or is this a silly idea with no merit? I understand the tax implications involved but am willing to bite the bullet for more investment options.

Answer: Good for you for being so diligent about saving for retirement. Your early start should give you a lot of options when you’re older.

For now, your question has an easy answer. Typically, you can’t roll a 401(k) account into an IRA while you’re still working for the employer that provides the 401(k).

There are a few exceptions. Once you turn 59½, some plans do allow such rollovers. Also, a few plans offer “mega backdoor Roths” that allow you to contribute after-tax money to a 401(k) and then do an “in service” conversion to a Roth IRA. This option helps high-income people get around the income limitation that would otherwise prevent them from contributing to a Roth IRA.

You will have the option of rolling your money into an IRA once you leave your job, but don’t assume such a rollover is always the right choice.

Most 401(k)s offer enough options to give you plenty of diversification, plus you may have access to low-cost institutional funds that wouldn’t be available in an IRA. You’re also protected by federal law that requires the companies offering 401(k)s to act as fiduciaries — in other words, they must put your best interests first. You often have the option of rolling your 401(k) balance into a new employer’s plan, which means you would be able to take loans from the plan. That’s not an option with an IRA.

There are no tax implications for rolling over a 401(k), by the way. Only if you convert the money to a Roth IRA will you owe taxes. A conversion may make sense, but you’ll want to talk to a tax pro first.