Q&A: Ask yourself these questions before using savings to pay off student debt

Dear Liz: I’m wondering whether I should use part of my emergency fund to pay off student loans. I currently have $15,000 in an emergency fund to cover three to six months of my living expenses and owe $18,000 in federal student loans. I’ve been feeling the itch to pay off a chunk of my student loans to reduce the years (and interest) I have to keep paying. I’d like to use $5,000 to $6,000 of my emergency fund to put toward the loan. For context, I’m already contributing 15% to my 401(k) and have no other debt.

Answer: First of all, well done. The fact that you have any emergency fund puts you ahead of the game, plus it’s great that you’re also saving for your retirement and avoiding credit card debt.

There are a few things to consider before using savings to pay down your loan. “Prepaying” a student loan is different from paying down credit cards. Reducing credit card debt typically frees up additional credit that you could use in an emergency. Paying down credit card debt also can help your credit scores by reducing your “credit utilization,” or the amount of your available revolving credit that you’re using. Extra money sent to a student loan lender, by contrast, can’t be clawed back if you should need it and doesn’t help your scores as much.

Federal student loan debt has other advantages. Interest rates tend to be low, and up to $2,500 of interest can be subtracted from your income even if you don’t itemize. That is a valuable “above the line” adjustment that can help you qualify for other tax breaks.

You shouldn’t hang on to debt just because of the tax savings, of course, since the value of the tax break usually is much less than the interest you pay. But most people have better things to do with their money than pay down low-rate, tax-deductible debt, especially if they have other types of debt, haven’t maxed out their retirement savings and don’t have an adequate emergency fund.

Which brings us back to your situation. You’ve checked all those other boxes. If your job situation is reasonably stable, then using a chunk of your savings to pay down debt can make sense — particularly if you have access to credit or other funds, such as help from friends or family, as a backup while you rebuild those savings.

Q&A: Why co-signing a loan, especially a student loan, can be a costly move

Dear Liz: I co-signed a student loan to help a 31-year-old woman complete her schooling to become a nurse. I know this was something I should not have done, but I just could not refuse her. I did not realize that because no payments had to be made until after the student’s graduation, the loan amount would double. I am looking into a life insurance policy on the student to protect my interest.

Is there any advice you can provide me other than paying off the loan? I know the student can complete a form to take me off this loan, but she will not qualify on her own.

Answer: She may not be able to take you off the loan now, but hopefully she can within a few years of graduation. Most private lenders will allow a co-signer to be removed from a student loan after a certain number of on-time monthly payments, typically 12 to 48. If she has good credit and a decent income, she also may be able to refinance this loan with another lender to get you off the note.

In the meantime, you’ll want to protect your credit, because a single missed payment can damage your credit scores. Contact the lender to find out what notice, if any, you’ll get if she falls behind on payments. Discuss with her the importance of making payments on time, every time, and ask her to contact you immediately if there’s any chance that won’t happen.

Just as many people don’t realize that they’re putting their good credit in the other person’s hands when they co-sign a loan, many also don’t realize what can happen if they take a lender up on its offer to defer payments until graduation.

The loan amount swelled because of something known as capitalization. Because payments aren’t being made, the unpaid interest is being added to the loan amount and dramatically increasing what the two of you owe.

If the loan were a subsidized federal loan, the government would pay the interest while the student was in school. With unsubsidized federal loans and private student loans like the one you signed, it’s smart to start making payments immediately to avoid capitalization and having to pay interest on interest.

Q&A: Social Security’s widespread benefits

Dear Liz: I encourage you to educate your readers about the real intention of Social Security, as well as the real problem facing it. Social Security was designed as a safety net to keep the elderly, disabled and orphaned from abject poverty. It was not intended to provide decades of benefits to individuals who are not at risk of living in poverty. It does no good to further the inaccurate notion that everyone is entitled to “their share” from a social safety net meant for the poor.

Answer: You’ve misunderstood Social Security’s structure and its history.

Social Security was deliberately created as a social insurance program, not as welfare assistance. Workers fund the system themselves through payroll taxes. They have to pay into the system a certain number of years to qualify for benefits. In return, they receive inflation-adjusted income that they can’t outlive and that isn’t vulnerable to market downturns.

Social Security benefits are progressive, which means they’re designed to replace more income for a lower-paid worker than a higher-paid one. But people who pay more into the system get larger benefits than those who pay less, and benefits are not means-tested.

Programs for the poor tend to be easy targets for politicians, but Social Security’s universal nature contributes to its widespread support. More than 1 out of every 6 U.S. residents, or about 62 million people, collected Social Security benefits in June 2018.

Q&A: Stop judging that overspending friend

Dear Liz: My friend is not good with money. He has always lived above his means. He lived in a fancy apartment, leases a BMW and goes out to eat often. To make matters worse, he lost his job a year ago and had to move in with a mutual friend. He continues to spend money he doesn’t have. I tried to help him with his finances and setting a budget, but he lost interest after one conversation. He’s 41 with no savings and more than $10,000 in credit card debt.

My question: Should I feel guilty about inviting him to things? When he was unemployed, I suggested doing things that don’t cost money, but he never seemed interested. I’m planning a trip for my 40th birthday and I’d like to invite him, but I don’t think he has the self-control to say, “No, I can’t go, I can’t afford it” because it will add $2,000 or more to his debt. How do you deal with someone when you’re more concerned with his financial well-being than he is?

Answer: You let go of the idea that you’re responsible for another person’s behavior.

Financial planners often encounter clients who, despite the planners’ best efforts, sail blissfully on toward economic disaster. And those clients paid for the advice that could save them. You’re not being paid. Your friend may not have even asked for your help. So you can stop offering it.

This will be hard for you. You understand how important it is to avoid credit card debt and save for the future. You may be thinking that if you could come up with the right words, you could persuade him to change his ways. Give up that fantasy, because he won’t change — if he ever does — one second before he’s ready.

There are a number of things you can do to prepare for that moment, if it ever comes. The first is to let go of any judgmental attitudes and feelings you might have about his situation. He may already feel a lot of shame about his circumstances. Even if he doesn’t, he’s unlikely to seek you out if he feels judged and blamed.

The next is to look for other resources that might help him, such as a financial counselor or coach. You can get referrals from the Assn. for Financial Counseling & Planning Education. He may find it easier to work with a professional than a friend.

Finally, resist the urge to offer opinions or observations about his situation. He knows you’re there to help if he ever wants it, so wait to be asked.

Q&A: Get help claiming Social Security

Dear Liz: I read your column about the disabled woman who was asking about survivor benefits. I am 60 and my husband died when he was 65, but he was not receiving Social Security. We both paid into Social Security for our entire working careers and maxed out every year. I have been told that I can receive his benefits when I am 65. I wonder why I cannot collect his benefits now.

Answer: You can, but you may not want to if you’re still working and earning the kind of six-figure income needed to “max out” your Social Security taxes.

People who start Social Security benefits early are subject to an earnings test that withholds $1 in benefits for every $2 they earn above a certain amount, which in 2019 is $17,640. Social Security has a calculator to help you determine the effect on your benefit at https://www.ssa.gov/oact/cola/RTeffect.html. Your survivor’s benefit also will be reduced if you start it before your own full retirement age, which in your case is either 66 years and 8 months (if you were born in 1958) or 66 years and 10 months (if you were born in 1959).

Once you’ve reached full retirement age, however, the earnings test goes away, as does the reduction for starting benefits early. At that point, you could apply for full survivor benefits and leave your own retirement benefit alone to grow 8% each year until it maxes out at age 70. You can continue to work and receive benefits without facing any reductions.

Social Security can be astoundingly complex, and claiming decisions can be affected by a number of factors. AARP has a free Social Security claiming calculator, but it can’t deal with some situations such as survivor’s benefits, child benefits (for retirement-age people who have minor children) or the offsets associated with pensions that don’t pay into Social Security. For those, you would need to pay about $40 to use a more sophisticated calculator such as the one at MaximizeMySocialSecurity.com, or to consult a fee-only financial planner with experience in this area.

Q&A: Separated spouse is entitled to survivor benefits

Dear Liz: I am a 57-year-old disabled woman whose only income is $500 a month in Supplemental Security Income. I was legally separated from my husband when he died at age 59. Can I collect Social Security from his account?

Answer: Most likely, yes.

To generate a survivor’s benefit, your husband would have had to pay into the Social Security system for a certain number of years. Younger people need to have worked fewer years than older ones to provide benefits for survivors, but no one needs to have paid in for more than 10 years.

Because your husband died before reaching retirement age, your survivor benefit would be based on what his retirement check would have been at his full retirement age (which would be 67, if he was born in 1960).

You could get 100% of that benefit if you wait until your own full retirement age to collect. Reduced benefits are typically available when a widow or widower turns 60. Survivors who are disabled can start benefits as early as age 50, if the disability started before the death or within seven years.

If your marriage had ended in divorce, you could still have qualified for survivor’s benefits as long as the marriage lasted at least 10 years. (If a marriage lasted that long and the ex is still alive, a divorced spouse can qualify for spousal benefits, which are up to half the ex’s benefit.)

With survivor benefits, you have the option of switching to your own retirement benefit later, if it’s larger, or of switching from your own benefit to a survivor’s benefit, should that be the better deal.

Q&A: When is it time to take the money and run to a new investment advisor?

Dear Liz: My wife and I are in our early 30s. She has a stock portfolio that has positions in 20 blue chip stocks purchased primarily in the last 20 years. It was set up by her family and managed by a family friend at a large brokerage. Recently, the family friend retired and transitioned the portfolio to a new team at this brokerage. They basically told us that our portfolio underperformed and only saw an average of 3% growth per year over the last 20 years.

The new brokerage team is recommending we gradually transition our 20 positions into a portfolio of 300 stocks that will mirror an index. They would harvest any tax losses to offset the capital gains tax that would otherwise be due. They will charge a 1% fee, and after several years, we will probably have a portfolio that is entirely small positions in a huge number of companies.

My gut reaction was that if they want to mirror an index, why not just buy an index fund with cash freed up from tax-loss harvesting? My wife really feels most comfortable doing whatever her parents recommend and is overwhelmed by what I call advanced investing but wants us to make this decision together.

Answer: If your wife is being charged a 1% annual fee, she should be getting a heck of a lot more than investment management. One percent is the typical fee charged by comprehensive financial planners who offer a wide array of services including retirement, tax, investment, insurance and estate planning. If her portfolio is more than $1 million, the fee probably would be even lower.

Another, larger problem is that the new team of stockbrokers probably does not have a fiduciary duty to your wife. In other words, they’re allowed to recommend a course of action that is more profitable for them, even if there are better-performing and less-expensive options available. That, more than anything else, should be motivating her to find a new advisor who is willing to be a fiduciary.

You can help in a number of ways, starting with the advisor search. The National Assn. of Personal Financial Advisors, the XY Planning Network and the Garrett Planning Network all represent fee-only planners and can offer referrals.

You also can encourage your wife to educate herself about investing, since (as you know) it’s not rocket science and she needs to know the basics to responsibly handle her money. Relying on her family’s influence has left her with an undiversified, underperforming portfolio — and delivered her into the hands of people who probably don’t have her best interests at heart. It’s time to grow up and take charge.

Finally, you can stop referring to it as “our” portfolio. It’s lovely that she wants to share it with you, but the money is hers and she needs to take ownership.

Q&A: Timing spousal benefits

Dear Liz: My wife, who is 59, lost her job and has been unable to find a new one. Can she file for Social Security spousal benefits at 62? I plan to continue working.

Answer: For her to receive spousal benefits, you need to be receiving your own benefits. If you’re not yet 62, the youngest age at which you can claim retirement benefits, then her only option would be to file for her own benefit.

That may be the right course in any case. If you’re the bigger earner, it often makes sense for you to put off filing as long as possible to maximize not just your own check but the survivor’s benefit that one of you will have to live on once the other dies.

You can start your research into the best claiming strategy by using free calculators, such as AARP’s Social Security calculator or Open Social Security. If your situation is at all complicated — you have a minor child or a pension from a job that didn’t pay into Social Security — then consider paying about $40 to use a more sophisticated calculator, such as Maximize My Social Security, or consulting with a fee-only financial planner.

Q&A: Mom’s 94; one son handles her money, another wants more access to it

Dear Liz: I have two younger brothers, and the youngest was chosen as the executor of our widowed mother’s estate. The problem is that he doesn’t understand financials. Mom is 94. Her entire estate is invested in blue-chip stocks. The portfolio was carefully planned by our uncle and closely tracks the Dow Jones industrial average. With her present holdings, she has enough to live indefinitely in her nursing home.

Her portfolio is up 40% in the last two years, but my brother is worried that the stock market is going to crash. She could give me up to $15,000 a year, but he’s telling her $500 a month for each brother is good. I’m a retired electrical engineer and have managed contracts for the military worth many millions of dollars. Can I challenge my brother’s ability to manage our mother’s finances?

Answer: Sure, if you want to open up an all-out family war at this stage of your life. A better approach might be a collaborative one, in which the three brothers seek outside, expert advice to handle Mom’s affairs.

You might have been terrific at managing military contracts, but that doesn’t give you the background in taxes, estate planning and investment management that’s required in this situation. You may be overestimating how much her portfolio has grown — the Dow is up about 25% in the last two years, not 40% — while underestimating both the risk of a downturn and the effect of larger withdrawals.

Your brother, meanwhile, is understandably concerned about a portfolio that’s 100% invested in stocks. That would be a lot of risk, even if your mom had decades to ride out any downturn (which, obviously, she doesn’t). Remember that the stock market lost roughly half its value a decade ago and lost about 90% during the Great Depression.

If your mom’s portfolio could take such a hit and still produce enough for her to live on, then larger distributions might make sense. Maximizing the annual gift tax exclusion, which allows her to give away $15,000 a person without filing gift tax returns, may be desirable if her estate is worth more than $11 million and could be subject to estate taxes. If she’s not wealthy, though, distributing $45,000 each year to three of you could increase her risk of running out of money.

A fee-only financial planner could analyze that risk and recommend a prudent course of action. The planner also could help arrange the necessary documents that would allow your brother to manage your mom’s financial affairs. Right now, it’s not clear whether those are in place.

Your brother is not yet the executor, because your mother is still alive and executors are in charge of distributing an estate after someone dies. If she wants him to make decisions for her should she become incapacitated, she should give him her power of attorney or name him as the successor trustee of her living trust. Otherwise, he probably would need to go to court to be named conservator.

It may rankle that your mom put him in charge of her estate, rather than you. If he’s trustworthy, though, you should put aside the idea of challenging him for control, especially if your main motivation is to get your inheritance early. Instead, offer to assist him in finding the professional advice he needs to help your mother and work together to make sure her remaining years are as free of family drama as possible.

Q&A: Take a look behind the credit-score numbers game

Dear Liz: I recently got an email from my credit card issuer stating my credit score had just dropped 21 points. Having a good credit score and not aware of any recent adverse actions, my first reaction was alarm.

Checking with the issuer online, I saw only advertisements for “protect your credit” services, so I phoned. I was informed the numbers came from Equifax credit bureau. I contacted Equifax as well as TransUnion and Experian, which resulted only in more offers of products to protect my credit. I downloaded my free credit reports from AnnualCreditReport.com and found nothing suspicious. I was finally directed to FICO, but an email sent more than a month ago remains unanswered.

Is it legal for these companies to market their products through presumably fictitious or even fraudulent means? What is the best way to find out my true credit score? Can my credit score suffer because I ask these questions in a public forum?

Answer: Knowing a little more about how credit scoring works may put your mind at ease.

There is no one “true” credit score. Lenders and other companies use many different kinds. FICO is the leading credit scoring company and the FICO 8 is the most commonly used score, but many companies use older versions or ones modified for their specific industry (such as the FICO Auto Score 5, for example). Plus, your FICO 8 from Experian may be different from your FICO 8 from TransUnion or Equifax because the scores are based on the information in your credit bureau files and the bureaus are separate, competing businesses that don’t always have the same information.

Then there’s the VantageScore, a rival to the FICO, which is used by some lenders and by many sites that offer people their credit scores for free. The VantageScore formula is different from the FICO formula, so your numbers could be different as well.

All these credit scores, however, are created solely using the information in your credit reports. Your income, gender, address, political opinions, computer operating system and online comments are not included in credit score calculations.

Some people are understandably confused about that. Various start-ups and researchers have suggested that non-credit information — such as information gleaned from someone’s social media postings or online surveys — could replace credit information in loan decisions. But the U.S. has fair credit reporting laws that probably would make such alternatives unworkable. (It would be nice if start-ups checked to see what regulations apply to their industry before sending out press releases, but that doesn’t always happen.)

Given that you didn’t see anything obviously wrong on your credit reports, you don’t need to worry too much. The credit score drop you describe might be because you charged more on a credit card than usual, had a credit limit lowered or applied for a bunch of credit in a short period of time. It probably will reverse itself over time.

Alerting you to credit score changes isn’t an illegal practice, even if the company’s primary purpose in keeping you up to date is to market credit-monitoring services to you. (Credit protection is a misnomer because these services can’t prevent identity theft. They can only alert you if it’s already happened.)

You did exactly what you should have done when you were alerted to the point drop — you went to AnnualCreditReport.com and checked your credit reports. If you want to put your mind further at ease, consider freezing your credit, a process that could prevent identity thieves from opening new accounts in your name.