Q&A: The ups and downs of reverse mortgages

Dear Liz: I have been a reverse mortgage specialist for the last 12 years and had some thoughts about the writer who complained that the $40,000 she initially borrowed had grown to a debt of $189,000, or more than her home was worth.

Using a compound interest calculator, it would take about 16.5 years for the debt to grow that large. The borrower would have lived in their home for all that time without making payments toward the debt, although they were still responsible for taxes, insurance and maintaining the property. They can stay in the home for as long as it’s their principal residence. Once they leave the home, the lender will sell the home and receive the difference between the sales price and the loan balance from the government insurance program that everyone with a reverse mortgage pays into. Otherwise, no lender would take out this loan for a potentially long term and risk losing money in the end. Maybe it was a good deal.

Answer: Possibly, but she regretted the decision anyway. She took out a reverse mortgage at a time of financial hardship and now wishes she hadn’t.

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People facing financial crises often develop tunnel vision and grab at solutions without thinking through the future costs of their decisions. (The excellent book “Scarcity: Why Having Too Little Means So Much” by Sendhil Mullainathan and Eldar Shafir explains the science of why that happens.)

Advertising for these loans can gloss over the downsides, such as potentially not being able to tap your equity later, when you may need it more. Reverse mortgages can be a good solution for some seniors but certainly not all of them.

Q&A: A shutdown reality check

Dear Liz: Recently a reader asked about withdrawing money from an IRA to pay credit card debt. You mentioned the many ways that was a bad idea, including the fact that retirement money is protected in bankruptcy court. Liz, the writer had only $10,000 in credit card debt. Bankruptcy should be a last resort. A lifestyle change or picking up a second job would be a better route to knocking out the debt.

Answer: “Picking up a second job” — really? Most people will be lucky to hang on to the ones they have in the coming months.

No one suggested that this reader should file bankruptcy, but anyone considering taking money from a retirement plan to pay debt should understand this major drawback — especially now. Bankruptcy experts expect business and personal bankruptcy filings to soar because of the pandemic.

You might want to check your other assumptions, as well. People typically don’t wind up in bankruptcy court because they refused to cut out their lattes or didn’t work hard enough. They get sick or disabled, lose their health insurance, get divorced, have a breadwinner die — or get stuck in a pandemic. Those with higher incomes and more savings may be better able to weather financial setbacks, but few of us are truly immune from their effects.

Q&A: The value of waiting

Dear Liz: This is a follow-up question to one you recently answered about tapping 401(k)s in order to delay the start of Social Security. I am 63 and retired early with a good pension that fully covers my basic living expenses. Any additional money would only be “gravy” for vacations and travel. Would I be taxed the same if I start taking Social Security now vs. waiting? I could easily tap my 401(k) to put off applying for Social Security.

Answer: When it comes to Social Security, if you can wait, you probably should.

Many middle-income people who have retirement funds will pay higher taxes if they start their benefits early, according to researchers who studied the “tax torpedo,” which is a sharp increase and then decline in marginal tax rates caused by the way Social Security benefits are taxed. The researchers found that many could lessen its effects by delaying the start of Social Security and tapping retirement funds instead.

If you’re married and the primary earner, it’s especially important to delay as long as possible because your benefit determines the survivor benefit that one of you will receive after the other dies.

Q&A: Culture and parental advice

Dear Liz: You recently answered a question from a parent who wanted to know how to fix a financial issue in an adult child’s marriage. Your advice was basically to butt out. I think that may depend on culture. What if your advice saved your child’s marriage? What if it prevented your child from going into bankruptcy? Would it be worth the uncomfortable conversation? In some cultures, the approach is to butt in and confront the issue; if it causes problems, well then you deal with that also.

Answer: There may well be a culture in which the interference of in-laws is gladly received, rather than merely tolerated. There may even be people who enjoy being the target of unsolicited advice. It’s hard for some of us to imagine, but it’s certainly possible.

It’s probably safer to assume that your counsel is unwelcome and annoying unless it’s been specifically requested — and often even then.

Q&A: Different approaches to marital finances

Dear Liz: Thank you for mentioning that many couples like to keep their finances entirely or mostly separate. Our solution was to create a joint bank account just for paying joint expenses, such as rent, food, entertainment together, vacations and so on. We each funded this account proportionately, based on our income (for example, the person earning 65% of the total income contributed 65% of the funds). Expenses, such as gifts to our separate children, entertainment on our own, car payments and all personal expenses were paid out of our own separate accounts. Each year at tax time, we’d revise the proportion of the joint account, if necessary, based on our separate tax return figures. It was so simple and tension-free. This was a second marriage for both of us, and we never had disagreements about money.

Answer: Congratulations for finding an approach that worked so well for both of you. As you demonstrate, there’s no one right way for couples to handle their money. Some prefer to have everything in joint accounts, others keep everything separate, and most are somewhere in between.

Q&A: An emergency kit document hack

Dear Liz: Thanks for answering my question about storing hard copies of financial services records for emergency preparedness. My wife and I finally reached a compromise: We printed out our account numbers, but we attached code names to them that only we would recognize. Now both of us are comfortable that even though someone might have our account numbers, they’ll never know which financial institution to contact.

Answer: That’s a terrific compromise that keeps your important financial information accessible to you but not to an identity thief.

Q&A: Required distributions and charity

Dear Liz: In a recent column, you mentioned that after age 70½, one can donate up to $100,000 to a charity directly from an IRA. Can one still take that as a charitable donation on income tax forms? If I have a required minimum distribution of $10,000, but make a $10,000 donation to a charity, does that take care of the required minimum distribution for that year?

Answer: The $10,000 charitable contribution would count as your required minimum distribution for the year and the money would not be included in your income, but you can’t also deduct the contribution. That would be double dipping.

As a refresher: Money doesn’t get to stay in retirement accounts forever. At some point, withdrawals must begin and those withdrawals are typically taxed as income. Congress recently changed the rules so that required minimum distributions now start at age 72 (they used to start at age 70½). But so-called qualified charitable distributions — donations made directly from a retirement account to charity — can still begin at 70½.

Before you make a qualified charitable distribution or any other withdrawal from a retirement account, consult with a tax pro to make sure you understand the rules that apply to your situation. Penalties for mistakes can be high, so it pays to get expert help.

Q&A: A tricky Social Security plan

Dear Liz: In a recent column, you described the difference between withdrawal and suspension of Social Security benefits. I am 64 and want to take Social Security for two months to get out from under a few one-time bills. I’ll then withdraw my application and pay back the money. Do I understand that I’d have 12 months to pay back the funds? Is this something that can be done every 12 months? I see it as an interest-free short-term loan. Of course this only works if the money is paid back.

Answer: The answer to both your questions is no. You’re allowed to withdraw an application only once, and it must be in the 12 months after you start benefits. Once you submit your withdrawal request, you have 60 days to change your mind. If you decide to proceed, you must pay back all the money you’ve received from the Social Security Administration, including any other benefits based on your work record such as spousal or child benefits, plus any money that was withheld to pay Medicare premiums or taxes. In other words, you have a two-month window to pay back the funds, not 12 months.

If you can’t come up with the cash, you’d be stuck with a permanently reduced benefit. You could later opt to suspend your benefit once you’ve reached your full retirement age, which is between 66 and 67. (If you were born in 1956, it’s 66 years and four months.) At that point, your reduced benefit could earn delayed retirement credits that could increase your checks by 8% for each year until the amount maxes out at age 70.

There are a few situations in which starting early and then suspending can make sound financial sense, but a short-term cash need is not typically one of them.

Q&A: Avoiding Medicare sign-up penalties

Dear Liz: Someone recently asked you if signing up for Medicare is mandatory. Your answer implied no, one does not have to sign up at 65. However, it is my understanding that if a person does not enroll when first eligible, they will be hit with large penalties on their Medicare premiums if they sign up later. Am I missing something?

Answer: Not at all. That answer was too short and should have mentioned the potentially large, permanent penalties most people face if they fail to sign up for Medicare Part B and Part D on time.

To review: Medicare is the government-run healthcare system for people 65 and older. Part A, which covers hospital care, is free. Medicare Part B, which covers doctor’s visits, and Part D, which covers prescriptions, typically require people to pay premiums. Many people also buy Medigap policies to cover what Medicare doesn’t, or opt for Medicare Part C. Part C, also known as Medicare Advantage, is an all-in-one option that includes everything covered by Part A and Part B and may include other benefits.

There’s a seven-month initial enrollment period that includes the month you turn 65 as well as the three months before and three months after.

People who don’t sign up when they’re first eligible for Part B usually face a penalty that increases their monthly cost by 10% of the standard premium for each full 12-month period they delay. For Part D, the penalty is 1% of the “national base beneficiary premium” ($33.19 in 2019) times the number of full months the person was uncovered.

People who fail to enroll on time also could be stuck without insurance for several months because they may have to wait until the general enrollment period (Jan. 1 to March 31) to enroll.

People typically can avoid these penalties if they have qualifying healthcare coverage through a union or an employer (their own or a spouse’s). When that coverage ends, though, they must sign up within eight months or face the penalties. Also, they might not avoid the penalties if their employer-provided coverage becomes secondary to Medicare at 65, which can happen if the company employs fewer than 20 workers. Anyone counting on union or employer coverage to avoid penalties should check with the company’s human resources department and with Medicare to make sure they’re covered.

The original letter writer had no income to pay Medicare premiums, so the answer also should have included the information that Medicaid — the government healthcare program for the poor — might help pay the premiums. People in this situation should contact the Medicaid office in their state. (Medicaid is known as Medi-Cal in California.)

Q&A: Figuring homes’ adjusted basis

Dear Liz: In your response to a question about the adjusted basis of a residence after the death of a spouse, you state that the surviving spouse may add to the adjusted basis “any commissions or fees paid to purchase the property and the cost of improvements.” Your example adds $150,000 in “improvements over the years” to the $850,000 value of the home at the time of the spouse’s death in 1992. Wouldn’t those improvements (and other costs) have to be made after the date of the spouse’s death, since otherwise they would already be included in determining the value of the home at the date of death?

Answer: Good point. If the surviving spouse lives in a community property state, only improvements that happened after the date of the first spouse’s death would increase the basis, because both halves of the property get a step up to the current fair market value when one spouse dies. In other states, only the deceased spouse’s half of the property would get the step up. The surviving spouse can add his or her half of the improvements made before the death, and anything done after the death, to the tax basis to determine home sale profits.