April 15, 2013 By

401(k) loans can get really expensive

Dear Liz: I bought my condo in 2009. I took out a loan on my 401(k) account to use for the down payment. I left my job in early 2012, and at the time didn’t have the money to pay back the loan, so the balance was treated as a distribution. I now owe the IRS $10,000 and don’t have the money to pay them, nor can I afford monthly payments beyond about $50. I can’t borrow any money from a family member or friend. My tax guy suggested (another) 401(k) loan, but I’m really reluctant to go deeper into debt. Any suggestions?

Answer: Thank you for providing a vivid example of why people should think twice before dipping into retirement funds to buy a house. Not only are you facing a steep tax bill, but the money you withdrew can’t be restored to your account, so you’re losing all the tax-deferred gains that cash could have earned over the coming decades. You can figure that every $10,000 withdrawn costs you at least $100,000 in lost future retirement funds, assuming an 8% average annual return on investment over 30 years. If you’re 40 years from retirement, the toll can be twice as large.

So it would be good, if at all possible, to leave your retirement funds alone from now on. That means you need to come up with the cash to pay what you owe, and $50 a month doesn’t cut it. To use an IRS payment plan, you’ll need to come up with about $140 a month to pay your bill off within the required 72 months.

Fortunately, there are plenty of ways to trim your spending so you can free up more money to pay this bill. These ways include, but aren’t limited to: ending your pay TV subscription, preparing meals at home instead of eating out, trading your smartphone for a dumber one or at least switching to a prepaid plan, selling or storing your car and using public transportation, or selling your condo and moving to a cheaper place.

When people have virtually no discretionary income left after paying bills, and they’re employed, the culprits are often their housing or transportation costs, or both. Reducing these can be painful but may be necessary if you want to get on more solid financial footing.

Filed Under: Credit & Debt, Q&A, Retirement, Taxes Tagged With: , , , , ,
March 18, 2013 By

Should you borrow to pay a tax bill?

Dear Liz: Help! We’ve just received devastating news from our accountant that we owe around $11,000 to the IRS and the state for 2012 taxes. The reason for the huge bill is that we cleaned out my husband’s IRA to pay for our son’s college expenses. My husband is almost 65 and working part time after being laid off, and I’m 61 with a full-time job. What is the best way to pay this bill? Here are the options I can think of: 1) Cash out my three-month emergency certificate of deposit of $12,000 that I’ve saved to cover expenses in case I get laid off. 2) Take money out of my IRA. 3) Use a credit card check that will be at zero percent for the first 12 months and then will slide to 8.9%. 4) Arrange a payment loan with the IRS. 5) Sell our house in which we have 70% equity. Which is best?

Answer: Let’s take No. 2 off the table, shall we? If you learn nothing else from this experience, it should be that tapping retirement funds can trigger a big (and often unnecessary) tax bill.

Selling your house over an $11,000 bill is overkill, so let’s eliminate that option as well. Which leads us to three remaining possibilities: Use cash, borrow from a credit card or borrow from the IRS.

Borrowing incurs costs. That zero percent credit offer almost certainly comes with a fee, which is usually 3% to 5% of the total. If you can’t pay the balance within a year, you start incurring interest charges.

The short-term rate the IRS charges for installment loans is pretty low — lately it’s been around 3% — but you also typically incur late-payment penalties. The penalty typically is one-half of 1% of the tax you owe each month or part of a month until the bill is paid in full. If you file by the return due date, that rate drops to one-quarter of 1% for any month in which an installment agreement is in effect. The maximum penalty is 25% of the tax due.

How much either option will cost you depends on how long you take to pay the bill. The cost for cashing out the CD is, by contrast, almost zero. Whatever tiny amount of interest you’re getting is far less than what borrowing would cost you. If you should get laid off before you rebuild your emergency fund, your access to cheap credit could come in handy.

Going forward, let your son pay for his college expenses and conserve what’s left of your resources for retirement.

Filed Under: Credit & Debt, Saving Money, Taxes Tagged With: , , , , ,
July 9, 2012 By

Watch out for tax refund theft

Dear Liz: My cousin had his house broken into a little over a year ago. A lot of things were taken, but insurance replaced most of what he thought was missing. This year after he filed his return he was contacted by the IRS, which told him that a return using his information had already been filed and the refund check cashed. The IRS is investigating the situation now, but I really worry about what is going to happen to his Social Security in the future if someone else is using his numbers or those of his children. Do you have any information on what steps he should take?

Answer: Theft of tax refunds is a growing problem. In fact, tax identity theft is the No. 1 fraud on the IRS’ list of Dirty Dozen Tax Scams of 2012.

The fraud is often perpetrated by organized criminal gangs that con, steal or buy people’s personal information to create bogus returns. Some people fall right into the bad guys’ hands by responding to emails that purport to be from the IRS. (The IRS doesn’t email people to request personal or financial information.)

If the problem isn’t resolved within a few months, your cousin should contact the agency’s Identity Protection Specialized Unit at (800) 908-4490.

Since the criminals already have his Social Security number and other important financial information, he also should put security freezes on his credit reports at all three bureaus. Links to the bureaus and other information for identity theft victims can be found on the IRS’ site at http://www.irs.gov.

Filed Under: Identity Theft, Q&A, Taxes Tagged With: , , ,
April 16, 2012 By

News you can use right now

Here’s a round-up of good recent stories tied to Tax Day (deadline’s tomorrow) and one of my favorite topics, credit scores.

Can’t pay? Amy Feldman’s article “What if you can’t pay your taxes?” for Reuters walks you through what to do if you’re facing a big bill, rather than a refund. Bottom line: don’t ignore the problem.

Tax liens and credit scores. The IRS has many ways to make your life miserable if you don’t pay your taxes. One weapon used by the IRS and other tax authorities is the tax lien, which can trash your credit scores and which is one of the few negative items that can show up on your credit report indefinitely if you fail to pay. Learn more from Tom Quinn’s column “Not paying your taxes can hurt your credit score” on Credit.com.

Plan to buy a car with your refund? If you’re one of the many getting money back from Uncle Sam and considering using it to buy another car, beware. Dealers know you’re coming, and you don’t want to have a big red target on your back. “Dealers are well aware that buyers may suddenly have an influx of cash on hand this time of year, so it’s not uncommon to see promotions and offers tied to tax season,” says Carroll Lachnit, Consumer Advice Editor at Edmunds.com. “And while there are good deals to be had on new cars, we strongly encourage consumers to take advantage of every research tool at their disposal before they plunk down their refunds as down payments.” For more, read Edmunds.com’s “Do your research before spending tax refund dollars at the car dealership.”

Good credit scores and a fat down payment may not be enough. You’ve heard that it’s harder to get mortgage these days, but you might be surprised at how much harder it is. Real estate columnist Kenneth Harney details the average FICO scores, down payments and debt-to-income ratios of those who did and didn’t get a mortgage in February. Most shocking: the group that got turned down had numbers that would have made them great candidates for loans just a few years ago.

Unexpected ways to better your numbers. Speaking of credit scores, Daniel Bortz wrote “6 surprising ways to boost your credit score” for U.S. News. I’m quoted, along with Beverly Herzog of Credit.com, Bill Hardekopf of LowCards.com and Anthony Sprauve of FICO.

 

Filed Under: Liz's Blog Tagged With: , , , , , ,
April 4, 2012 By

Missing or bogus tax forms? Here’s what to do

A couple of my Facebook fans haven’t gotten their taxes done because they’re missing key forms–one has a W-2 that’s incorrect, while the other is missing a 1099-R.

These aren’t unusual problems, so I’m hooking you up with the resources you’ll need if you’re facing a similar situation. Here’s what to do:

Gather relevant information. In the case of a missing or incorrect W-2, you’ll want to have handy the employer’s exact name, address and Employer Identification Number (EIN) if possible. (You can find the EIN on a previous year’s W2, if you have that.) It’s also handy to know what the missing or incorrect form SHOULD say, if you have that information from your year-end pay stub or bank records.

Call the IRS at 800-829-1040. Expect to spend a fair bit of time on hold, as they’re a bit busy this time of year. In the future, you can call the agency if you haven’t received a form by Feb. 15 (in other words, don’t wait until the last minute).

Explain the problem. With missing or incorrect W-2s, ask the agent to open a Form W-2 complaint. You’ll need to fill out a Form 4852, which is a substitute W-2 you fill out using the information you have, such as a year-end pay stub. You can find the form and other information here. Missing 1099s often aren’t a big deal, since you don’t need to attach them to your form, with the exception of the 1099-R, which reports tax withheld on retirement plan distributions.

Expect this to delay your refund. If you can’t get a corrected form in time (which is doubtful, at this point), your refund may be held up while the IRS verifies your information.

You may need to file an amended return. If you get a corrected form after the tax-filing deadline and the amounts are different than the ones you entered on your form, you may have to file a 1040X amended return.

You could also consider filing for an automatic six-month extension. You’ll still need to pay any tax owed by April 17, and could face some penalties if you underpay, so use this as a last resort.

Filed Under: Liz's Blog Tagged With: , ,