Q&A: Paying taxes with plastic

Dear Liz: I am selling a rental property that I have owned for several years. I know I could do a 1031 exchange, which would allow me to put off the tax bill by investing in another commercial property. But I just want out. I’ll pay the capital gains tax and invest the rest of the proceeds. I am considering paying the taxes by credit card and taking on the 3% premium to get rewards points offered through the card issuer. Is this a dumb idea, or does it have some merit?

Answer: The companies that process federal tax payments have processing fees of just under 2%, not 3%. You’ll still want to make sure you get more value from your rewards than you pay in fees, and that’s not a given. If your card offers only 1.5% cash back, for example, charging your taxes doesn’t make a lot of sense. But the math changes if you can get more than 2% in rewards, or if you could use the charge to help you meet the minimum spending requirements for a new credit card with a generous sign-up bonus.

If you do charge your taxes, you’ll obviously want to pay the balance in full before incurring any interest.

Q&A: Refreshing an old credit card

Dear Liz: I have and use three credit cards, two of which offer cash-back rewards. The third has no rewards program, so I would like to get rid of it and replace it with a new card that offers cash back or miles. But I’m afraid if I cancel this card my credit score will take a hit, especially since the card has a big chunk of my overall credit limit. What do you suggest?

Answer: You can ask the issuer for a “product change,” which allows you to swap one card for another without closing your account. Typically, your history with the old card is simply transferred to the new one, as is your credit limit.

The new card must be from the same issuer and you usually won’t qualify for any sign-up bonuses. But you won’t risk damaging your scores by closing one account and applying for another.

Research the issuer’s offerings and know which card you want before you call. This is usually a fairly routine process, but if you encounter any resistance, just mention that your other option is to cancel the card. If you’ve been a good customer, the issuer probably will want to keep your business.

A product change also can be a good idea if you want to switch from a rewards card with a high annual fee to one with a lower fee, or no fee. Any rewards you’ve already earned may not be transferable, so be sure to ask.

Q&A: Don’t file an amended return after the stimulus tax break. The IRS is begging you

Dear Liz: You might want to inform your readers that they do not need to file an amended return if they filed before Congress passed its most recent stimulus plan, which excludes the first $10,200 of unemployment benefits. The IRS will automatically recalculate their taxes and refund the taxes paid on that amount of benefits.

Answer: In fact, the IRS is begging people not to file amended returns. (An exception, the IRS has said, is for those who the tax reduction would make newly eligible for the earned income tax credit or other tax breaks for lower income people.) The agency is still processing a backlog of returns and correspondence while issuing a third wave of stimulus payments and gearing up to send monthly child credit payments to millions of families.

You may need patience, however. The IRS has promised to refund any taxes paid on the first $10,200 of unemployment benefits earned last year, but has said the money will go out “this spring and summer.”

Q&A: How the pandemic made working with a financial planner easier

Dear Liz: You often recommend in your column to seek the advice of a fee-only financial planner. Where would I find such a financial planner? Our understanding is that a person has to have at least $1 million of savings to invest before a “fee-only” financial planner will consult with you. Can you be more specific?

Answer: Once upon a time, it was difficult to find fee-only financial planners if you didn’t have a lot of money to invest. Many required you to invest at least $250,000 and charged 1% of those assets annually.

Today you have many more options.

There are now fee-only planners who work on an hourly basis (such as those affiliated with Garrett Planning Network) or who charge monthly retainer fees (the XY Planning Network).

There are also accredited financial counselors and accredited financial coaches (Assn. for Financial Counseling & Planning Education) who often work on a sliding scale. The National Assn. of Personal Financial Advisors and the Alliance of Comprehensive Planners are two other organizations that represent fee-only planners.

One positive outcome of the pandemic is that many more planners now work virtually, which widens your potential options.

Also, many discount brokerages and robo-advisors now offer more affordable ways to get fiduciary advice. (“Fiduciary” means that the advisor is required to put your best interests first.)

Many use a hybrid model, with computer algorithms directing your investments plus access to a human advisor by phone, email or video call. The cost is typically 0.3% to 0.5% of the assets you have invested with the company, which is significantly cheaper than the 1% traditionally charged by financial planners.

Q&A: House transfer in a trust

Dear Liz: My dad set up a living trust that included his house, which has a mortgage on it. The lender accepted the transfer of the home to the trust. Dad recently passed away so the house should transfer to my sister and myself. Can the lender trigger the due-on-sale clause? Or make me or my sister qualify for the mortgage?

Answer: A federal law known as the Garn-St. Germain Depository Institutions Act of 1982 details several situations in which lenders can’t enforce due-on-sale clauses, including when a home passes to a relative or joint tenant, said Jennifer Sawday, an estate planning attorney in Long Beach. The law applies to residential properties with four or fewer dwelling units.

You and your sister won’t have to qualify for a new loan but can continue making payments under the current mortgage terms. If you can’t afford the payments, you’ll need to consider other options, such as refinancing or selling the home.

Q&A: IRA intricacies when one spouse isn’t working

Dear Liz: Due to the pandemic, I did not work during 2020. Can I contribute to a spousal IRA for 2020 since my husband still has an income and will be contributing to his Roth IRA? Does it need to be a separate account from my existing IRAs?

Answer: As long as your husband has earned income, you can contribute to your IRA. You don’t need to set up a separate account to make this spousal contribution.

Whether or not your contribution is deductible will depend on your income and whether your husband is covered by a workplace retirement plan such as a 401(k). If he’s not, your spousal contribution is fully deductible. If he is covered, then your ability to deduct your contribution phases out for a modified adjusted gross income of $196,000 to $206,000.

Q&A: Where to find the most bang for your savings buck. Spoiler: On Wall Street

Dear Liz: I recently sold my home and want to put away funds for my daughters. I want to place $130,000 each in an account that will earn 7% to 10% interest for 30 years or so, providing them with a comfortable retirement fund. I’m thinking of having them start with a low-cost index mutual fund. What are the drawbacks to placing all of the funds in one mutual fund account?

What are the tax implications?

Answer: Stock market index funds mimic a benchmark, such as the Standard & Poor’s 500. That means you’re typically getting at least some diversification, which can help reduce the volatility of your investment.

You could reduce volatility even more by including bond market index funds, or opting for a target date fund that spreads the money across a mix of investments — stocks, bonds, cash. Target date funds are labeled with a specific year in the future and gradually reduce risk as that date approaches. Or you could consider a robo-advisor, which uses computer algorithms and ultra-low-cost exchange-traded funds to create and manage a portfolio.

These investments typically will generate taxable returns, so you’ll want to discuss the implications with a tax pro.

Also, you mentioned earning interest, but interest is what is paid on bonds and savings accounts. Returns are what investors earn on stocks and other higher-risk investments. No investment currently pays 7% to 10% interest. Over time, stocks typically generate average annual returns of 8% or so, but returns aren’t guaranteed and some years your stocks may lose money.

Q&A: Roth IRA contributions

Dear Liz: I am a retired public employee and receive most of my compensation in monthly payments, for which I get a 1099R form at tax time. The rest of my compensation also comes in monthly installments and I receive an annual W-2 for that. My question is: Can I deposit my W-2 amount in a Roth IRA?

Answer: You must have earned income to contribute to an IRA or Roth IRA — which you apparently have, since you’re getting a W-2 form from an employer. Your ability to contribute to a Roth begins to phase out with adjusted gross income of $125,000 if you’re single or $198,000 if you’re married filing jointly.

Assuming you’re 50 or older, you can contribute a maximum of $7,000 or 100% of what you earn, whichever is less.

Q&A: Backdoor Roth Ira conversions

Dear Liz: I am 65, self-employed and have a SEP IRA as well as a Roth IRA. I’ve had a few low-income years, and I find myself in a very low tax bracket, most likely lower than when I begin to take distributions and collect Social Security in a few years. What are the steps for a “backdoor Roth” conversion? As a self-employed person, do I even qualify?

Answer: A backdoor Roth is a way for higher-paid people to get around the income limit for Roth contributions. If you’re in a low tax bracket, that limit likely isn’t a problem for you.

What you’re probably asking about is a basic Roth conversion, where you roll money from your pre-tax SEP IRA into a Roth and pay the resulting taxes. Such conversions can make sense if you expect to be in a higher tax bracket later and you don’t have to tap your account to pay the taxes, but they’re not a slam dunk.

A too-large conversion could push you into a higher bracket. or increase your Medicare premiums or both. (Higher Medicare premiums are imposed when modified adjusted gross incomes exceed $88,000 for singles or $176,000 for married couples filing jointly.)

Financial planners often recommend converting just enough to “fill out” a low tax bracket. Let’s say you’re single and currently in the 12% federal tax bracket, which ends at $40,525. If your income is $25,000, you might convert about $15,000 of your SEP to avoid being pushed into the next bracket, which is 22%.

A tax pro or fee-only financial planner could advise you about how to proceed.

Q&A: Social Security and spousal benefits

Dear Liz: My wife and I are both 66 and have not yet filed for Social Security. I don’t plan on filing until I am 70. Is my wife able to file for her own retirement benefit now, which is much lower than mine? And then when I file at 70 years, can she switch to the spousal benefit rate, without any type of penalty?

Answer: Yes and yes. This is one of the few instances in which people can still switch from one benefit to the other.

If you had already applied, your wife’s retirement benefit would be compared to her spousal benefit and she would get the larger of the two amounts. Since you haven’t applied, however, no spousal benefit is available. Your wife could receive her own benefit and then switch to the larger spousal amount once you apply at 70, when your own benefit has maxed out.

Also, as long as your wife has reached her full retirement age (66 years and two months, if she was born in 1955), she won’t face the earnings test if she continues to work. That test otherwise reduces benefits by $1 for each $2 earned over a certain amount, which in 2021 is $18,960.