Ask Liz Weston

Get smart with your money

q&a

Q&A: 529 plans vs. education tax breaks

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Dear Liz: You recently mentioned in your column that you can’t use any of the three education tax breaks — the American Opportunity Credit, the Lifetime Learning Credit or the tuition and fees deduction — for expenses paid with 529 college savings plan money. This has me wondering if those 529 plans are really worth it.

Wouldn’t you have to have a really large amount invested to have enough earnings to make it worth not taking one of the credits?

Answer: If college were cheap, that might be a problem. But most people have far more college expenses than they can write off on their tax returns.

The average net price for one year at a four-year college — the published cost minus free financial aid such as grants and scholarships — was just under $13,000 last year, including tuition, fees, room and board. The average net price was around $6,000 at two-year public colleges and $23,550 at private four-year schools.

Many people pay a lot more, as the sticker prices at colleges continue to rise.

As mentioned in the previous column, the three available tax breaks are mutually exclusive, so you can’t take more than one in any given year.

The most generous credit, the American Opportunity Credit, reduces taxes dollar-for-dollar for the first $2,000 of college expenses and then by 25% of the next $2,000 — for a total of $2,500 per student.

If your qualified education expenses exceed $4,000, as they probably will, those tax-free 529 plan withdrawals will come in handy.

Q&A: “File and suspend” Social Security

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Dear Liz: You’ve been writing about the “file and suspend” option that allows you to delay taking Social Security while still reserving the ability to get a lump sum if you later change your mind.

If I file and suspend but choose not to take a lump sum before my benefit maxes out at 70, what happens to those funds? What happens to those funds if I die before 70?

Answer: Remember that Social Security is a pay-as-you-go program. The Social Security taxes you pay aren’t piled up in some kind of account, waiting for you to retire. Your taxes pay current retirees’ benefits, just as future workers’ taxes will pay yours.

When you delay starting Social Security, you’re rewarded with a potentially larger check each year you put off claiming until age 70. Your benefit grows by about 7% each year between age 62 and your full retirement age, which is currently 66.

Between full retirement age and 70, your benefit grows at 8% each year in what’s called “delayed retirement credits.”

If you file and suspend at your full retirement age, then change your mind, you can get a lump sum equal to all those checks you passed up since you filed. However, you lose the 8% delayed retirement credits you could have otherwise claimed.

Your benefit is reset to the lower amount you would have received at full retirement age, and that’s the benefit on which all future cost-of-living calculations would be made.

Should you die after filing and suspending, your surviving spouse would be able to benefit from those delayed retirement credits. His survivor’s benefit would be equal to what you could have claimed as of the date of your death.

Q&A: Waiting on Social Security

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Dear Liz: I started Social Security at 62 and did the spreadsheet myself showing the break-even point. I would have to be 80 before the graphs even cross.

You, and others, have to stop that business about waiting on Social Security if you can. My own mother lived to 90 and it is about quality of life, not collecting lots from the government.

Answer: Exactly. And since you have longevity in the family, you especially should have paid better attention to the message about the importance of delaying benefits.

If your mother started benefits at 62, or ended up living on a survivor’s benefit from a husband who started early, then her checks were 30% to 50% smaller than they could have been. That difference can be especially crucial in a person’s later years, when she’s far more likely to have outlived her other assets and need the additional money.

Remember that the decision to claim Social Security is separate from the decision to retire. People can retire early and draw from other accounts while putting off Social Security to maximize their checks.

Most people who try to do the math on spreadsheets fail to factor in the effects of inflation and taxes, among other factors.

You can get better calculations from one of the free calculators, such as the ones at AARP and T. Rowe Price. You can find a more robust calculator for about $40 at MaximizeMySocialSecurity.com and SocialSecurityChoices.com.

Another option is to read the recent bestseller published by Simon & Schuster: “Get What’s Yours: The Secrets to Maxing Out Your Social Security.”

Q&A: Budgeting for new college grads

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Dear Liz: My son will be graduating from college this June. He is fortunate to have already landed a good job, starting in August, and will be managing his own finances for the first time. His company provides a full benefits package, retirement fund, profit-sharing, a hiring bonus and all that good stuff.

I’d like to give him some guidance on how to organize and allocate his income between living expenses, liquid savings, student loan payments, charities, etc. What do you suggest? With graduations coming up, this might be a good time to help us parents get our kids off on the right foot.

Answer:One of the best things new college graduates can do is to continue living like college students for a little while longer.

In other words, they shouldn’t rush out to buy a new car or sign up for an expensive apartment when they get their first paychecks.

Pretending they’re still broke can help them avoid overcommitting themselves before they see how much of that paycheck is actually left after taxes and other nondiscretionary expenses.

A few other rules of thumb can help them get a good financial start. One is to immediately sign up for the 401(k) or other workplace retirement plan.

Ideally, they would contribute at least 10% of their salaries to these plans, but they should put in at least enough to get the full company match. If they aren’t eligible for the plan right away, they can set up automatic monthly transfers from their checking accounts to an IRA or Roth IRA.

Graduates don’t need to be in a rush to pay off their federal student loans, since this debt has fixed rates, numerous repayment options and various other consumer protections. Private student loans have none of these advantages, and so should be paid off first.

If your son has both types, he should consider consolidating the federal loans and opting for the longest possible repayment period to lower his payments. That would free up more money to tackle the private loans. Once those are paid off, he can start making larger payments toward the federal loans to get those retired faster.

One budgeting plan to consider is the 50/30/20 plan popularized by bankruptcy expert and U.S. Sen. Elizabeth Warren.

In her book “All Your Worth,” she suggested people devote no more than half their after-tax incomes to “must have” expenses such as shelter (rent or mortgage), utilities, food, transportation, insurance, minimum loan payments and child care. Thirty percent can be allocated to “wants,” including clothing, vacations and eating out, while 20% is reserved for paying down debt and saving.

Q&A: Thrift Savings Plan

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Dear Liz: I turned 50 last year but did not make the catch-up contributions I was eligible to make to my government Thrift Savings Plan. This mistake cost me approximately $5,000 in additional taxes in 2014.

To make matters worse, my wife also did not make catch-up contributions in 2014 or for the previous four years for which she was eligible to do so. Can we retroactively make catch-up contributions for the last three tax years and file amended tax returns so we can get additional tax refunds?

Answer: It’s highly unlikely you cost yourself $5,000 in additional taxes, since the catch-up contribution for people 50 and older in 2014 was only $5,500. Your federal tax rate would have been limited to your tax bracket, which is likely somewhere between 15% and 28%. You could have cost yourself $5,000 if you didn’t make any contribution to the plan, since last year’s limit was $17,500 or a total of $23,000 with the catch-up.

The short answer to your question about whether you can catch up with catch-ups is no.

Contributions to workplace retirement plans typically have to be made before the end of the plan year. IRAs, meanwhile, allow contributions until the due date for filing your returns, so that contributions for 2014 could be made until April 15, 2015, and contributions for 2015 could be made until April 15, 2016.

Presumably you’re now signed up to contribute the maximum to each plan.

If you have extra cash to invest, both you and your wife could open IRAs even though you’re covered by workplace plans. If your modified adjusted gross income (MAGI) as a married couple is $96,000 or less, you can deduct the full contributions of $6,500 ($5,500 plus a $1,000 catch-up) each. You can get a partial deduction if your MAGI is between $96,000 and $116,000.

If you can’t deduct your contribution, consider putting the money in Roth IRAs if you can. Roths don’t allow upfront deductions — but the money is tax free when withdrawn in retirement. You and your wife could contribute $6,500 each to a Roth if your MAGI is under $181,000.

Q&A: Social Security benefits and divorce

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Dear Liz: You’ve been answering questions about ex-spouses and Social Security benefits. My first marriage was longer than 10 years, and I was the primary earner. My ex remarried but later divorced again.

Does his getting remarried nullify his claims forevermore — or is his ability to claim spousal benefits based on my income back on the table as long as he remains unmarried?

Answer: It’s the latter. Your ex can claim spousal benefits based on your work record as long as your marriage to him lasted at least 10 years and he is not currently married.