Q&A: Understanding the gift tax

Dear Liz: I am 83 and have always been employed and a regular saver. I find myself in the unusual position of having amassed a considerable estate and, barring a financial or medical catastrophe, probably having more assets than I will use in my lifetime. Of course these assets will pass to my wife or other heirs on my death, but I would like to help them now. I am considering passing on monies to my sons and grandchildren. I find it hard to believe, but is it correct that I can give up to a total of $15,000 per year ($30,000 for a husband and wife) to my children and grandchildren in a given calendar year without federal or state tax implications for either party? Also, does the recipient need to be a close relative for this transaction to take place without creating a tax liability for either entity?

Answer: Right now you can give away millions of dollars without owing gift taxes. Gifts are tax-free to the recipient, and there’s no requirement that they be a relative.

The annual gift exemption limit of $15,000 is how much you can give away per recipient without having to file a gift tax return. You and your wife together could give $30,000 to as many people as you wanted without having to file such a return. If you have two married sons who have three children each, you and your wife could give each family of five $150,000 or a total of $300,000 without having to file a gift tax return.

Gift taxes aren’t due until the amount you give away over the annual limit exceeds the lifetime gift and estate exemption limit, which currently is $11.7 million per person.

Given your age and affluence, you should be working with an experienced estate planning attorney to make sure your assets go where you want after your death. The attorney can discuss smart gifting strategies for your individual circumstances.

Q&A: Here’s why you have many different credit scores

Dear Liz: Have you ever covered the fact that the credit score that a person receives from the reporting agencies is entirely different from the one provided to lenders? The difference I discovered was 819 vs. 710. I’m a retired lawyer who represented investors in securities arbitration for 20 years, so not easily shocked or surprised by financial fraud, but I was.

Answer: The fact that there are many different scoring formulas has come up frequently in this column. What you consider to be fraud is actually a manifestation of capitalism.

Credit bureaus are private, competing companies. So are the creators of scoring formulas. Lenders and other companies that use credit scores have many to choose from.

FICO is the leading credit scoring formula, but rival VantageScore has gained market share in recent years.

Both types of scores come in multiple versions. The latest version of the FICO is the FICO 10, although the FICO 8 continues to be the most-used score.

Meanwhile, mortgage lenders tend to use much older versions of the FICO formula. Scores also can be tweaked for different types of lending, such as auto loans or credit cards.

Credit bureaus have created their own proprietary scores, as well. What this means is that the same underlying data — what’s in your credit report at a given credit bureau — can create significantly different FICO scores, depending on which FICO formula was used.

Even the same type of score, such as a FICO 8, could vary depending on which credit bureau’s information was used and when the score was “pulled” or created. The credit bureaus typically don’t share information with one another. Plus the information in your credit reports is constantly changing as information is added or deleted.

So it isn’t shocking that the score your lender used was different from the one the credit bureau provided you. What would have been surprising is if the number had been the same.

Q&A: Social Security after a spouse dies

Dear Liz: My husband recently died. Since he and I received essentially the same amount from Social Security, I will not receive any additional money. Can you explain this? Social Security could not when I both called and went to the local office. I have not seen this addressed in your column. I would think this would be a problem for many spouses.

Answer: The issue of survivor benefits has been addressed frequently in this column, but unfortunately many people still don’t understand that their benefits will drop, sometimes precipitously, when their spouse dies.

When one member of a married couple dies, one of their two Social Security checks goes away and the survivor gets the larger of the two benefits. If your husband’s check had been larger than yours, that amount would become your survivor benefit. If your benefit was the larger of the two, you would continue getting that amount.

Many people don’t consider the impact their claiming decisions will have on their surviving spouse, which is unfortunate since the survivor could live years or even decades on this reduced income. Couples often can maximize their benefits and lessen the severity of this drop in income by making sure the higher earner delays their Social Security application as long as possible, ideally until it maxes out at age 70.

Q&A: Unexpected credit upswing

Dear Liz: I know there are different factors involved, but I find a recent upsurge in my FICO score inexplicable. My score went from about 740 to 815, according to a note in my most recent credit card statement. Yet I’ve done virtually nothing in the way of major credit activity — no purchases, no change in my already-low credit card use. I transferred about $800 from one card to another, and that’s it. If such small matters can affect the FICO score, it makes that score seem ridiculous. Can you offer any possible explanations?

Answer: Credit scoring formulas are a bit of a black box, but they are sensitive to how much of your available credit you’re using.

If you transferred the balance from a card with a very low credit limit to one with a higher limit, your scores typically would improve — although perhaps not as dramatically as the increase you’re describing.

Your scores might also improve if your balances dropped on other accounts or something that was negatively impacting your credit “fell off” or stopped being reported. The simple passage of time can improve your scores, as well, increasing the age of your credit accounts and the time since your last application for credit.

It’s impossible to say exactly what combination of factors may have affected the score you saw, but at least it moved in the right direction.

Q&A: Lenders were supposed to tell you about pandemic debt relief. What if yours didn’t?

Dear Liz: I had a problem last year and had no income so I couldn’t pay my bills for three months. I explained the situation to my creditors, but they still put the late payments on my credit reports. I called and sent letters, but it was no good: My credit score dropped to the mid-500s. How can I get the late payments taken off?

Answer: Last year, many lenders offered various kinds of hardship programs because of the pandemic. If you were approved for forbearance, the payments you missed should not have been reported as late. You could dispute the errors at the three credit bureaus (start at www.annualcreditreport.com) and ask the lenders to correct the record.

Unfortunately, lenders don’t always tell customers that forbearance or other hardship programs are available. If you weren’t given the option to enroll when you called to explain your problem, contact your lenders again, in writing, to point that out and request that the late payments be removed from your credit reports.

If a lender refuses to cooperate, consider making a complaint to the Consumer Financial Protection Bureau.

Q&A: Where should you keep your estate planning documents?

Dear Liz: What do you do with your will or living trust once it’s created? Do you put the document in your home safe or a safe deposit box at the bank? Leave it with a friend or relative? What’s to prevent someone who has access to your property from destroying that document? I heard of such a case where the will was never found and the wrong relative took everything.

I imagine you could leave it with your attorney with instructions to ensure it is abided by upon your death. But who will contact the attorney after your death to ensure your wishes are abided by? I know the coroner won’t do it, nor a funeral home.

Answer: Definitely don’t put the original document in a safe deposit box. Once notified of your death, your bank will typically seal the box until your executor can prove they have the legal right to retrieve it — and that will be complicated if the document naming them as executor is in the box.

Keeping the original in your own safe is better than leaving it at the bank, but still not ideal if you fear someone with bad intent could access it. For most people, the best option is to leave the original with their attorney. You can provide copies to your executor and other trusted people and give them your attorney’s contact information.

Q&A: Be wary of advisor motives

Dear Liz: In a recent column, you discussed the difference between fee-only vs fee-based financial planners. Most of my retirement dollars are in an IRA with one of the better-known investment companies. One of the advisors with that firm has advocated for an annuity with a well-known insurance company as a component of my portfolio. So, does this affect the advisor’s status of fee-only vs fee-based, or is this person to be only on the fee-based side of the equation? Or am I just confused?

Answer: You’re confused because it’s confusing — deliberately so. Many investment companies, including the better known ones, don’t make it clear that their advisors do not have to put your best interests first. Most are held to a lower “suitability” standard that allows them to recommend an investment that isn’t as good as the alternatives, simply because it pays them a higher commission.

If you want an advisor that puts your interests ahead of their own, seek out a fee-only financial planner — one who only accepts fees paid by clients rather than commissions and other incentives. This advisor should be a fiduciary, meaning the advisor is required to put your best interests first. The advisor must be willing to state, in writing, that they will put your interests ahead of their own.

It’s especially important to check with such a fiduciary advisor before purchasing an annuity, since these are complex products with potentially significant downsides that could be glossed over by someone who’s being paid to sell you one. An annuity could be the right fit for you, or it could be an expensive mistake. Get an objective review from a fiduciary before you buy one.

Q&A: Windfall elimination provision explained

Dear Liz: I understand your explanation of the windfall elimination provision that reduces Social Security benefits if someone is receiving a pension from a job that didn’t pay into Social Security. I am a teacher with such a pension who also worked more than 10 years in the private sector. I’d accept the explanation and the reduction if the WEP were applied in all 50 states. As you know, it is not. How is this reduction justifiable in any way?

Answer: The idea that WEP doesn’t apply in all states is a myth. WEP applies regardless of where you live. What matters is whether you’re getting a pension from a job that didn’t pay into Social Security. Some states provide such pensions while others don’t.

“If a state doesn’t provide its workers with their own pension and instead has them join Social Security, then exempting them from the windfall elimination provision is fully appropriate,” says economist Laurence Kotlikoff, president of Economic Security Planning Inc., which offers Social Security claiming software at MaximizeMySocialSecurity.com.

As mentioned earlier, WEP is not designed to take away from you a benefit that others get. Rather, the provision is designed to keep those who receive pensions from jobs that didn’t pay into Social Security from getting significantly higher benefits than workers who paid into the system their entire working lives.

That can happen because of the progressive nature of Social Security benefits, which are meant to replace a higher percentage of a lower-earner’s income than that of a higher earner.

People who don’t pay into the system for many years can appear to be much lower earners than they actually are. Without adjustments, they would get bigger benefit checks than people in the private sector with the same income who paid much more in Social Security taxes.

Q&A: When mortgage shopping, does checking your credit scores lower them?

Dear Liz: We’re trying to refinance a mortgage. All of the mortgage lenders claim that checking our credit scores will not affect the scores. However, that is not true. What gives? The three credit bureaus all list “too many inquiries” and penalize us. Does calling them do any good or make it even worse?

Answer:
Checking your own scores is considered a soft inquiry that has no effect on your scores. When a lender checks your scores, there can be a small ding, but credit scoring formulas also have a feature that reduces the effect when you’re shopping for a mortgage.

Essentially, all the mortgage inquiries made within a certain amount of time are grouped together and counted as one. In addition, the formulas ignore any mortgage inquiries made within the previous 30 days. The amount of time you can shop varies with the credit scoring formula, so it’s generally a good idea to concentrate your shopping into a two-week period.

What you don’t want to do when you’re in the market for a mortgage is to apply for other credit. Those inquiries are not grouped with your mortgage inquiries. The effect of these inquiries fades quickly and is usually pretty small — typically 5 points or less for FICO scores, for example. But even a small ding could cause you to pay more in interest if your scores aren’t already excellent.

Q&A: Social Security windfall elimination provision

Dear Liz: I was referred to an answer you wrote in 2017 explaining Social Security’s windfall elimination provision. It was the clearest explanation I have seen. I receive a government pension and a reduced Social Security check from the provision and am now fine with how it came to be, thanks to your post.

Answer: Many people are understandably upset that their Social Security benefits are reduced when they receive a pension from a job that didn’t pay into the Social Security system. Understanding why this happens may help. Here’s a reprint of the question and answer from 2017:

Dear Liz: I am a public school teacher and plan to retire with 25 years of service. I had previously worked and paid into Social Security for about 20 years. My spouse has paid into Social Security for more than 30 years. Will I be penalized because I have not paid Social Security taxes while I’ve been teaching? Should my wife die before me, will I get survivor benefits, or will the windfall elimination act take that away? It’s so confusing!

Answer: It is confusing, but you should understand that the rules about windfall elimination (along with a related provision, the government pension offset) are not designed to take away from you a benefit that others get. Rather, the rules are set up so that people who get government pensions — which are typically more generous than Social Security — don’t wind up with significantly more money from Social Security than those who paid into the system their entire working lives.

Here’s how that can happen.

Social Security benefits are progressive, which means they’re designed to replace a higher percentage of a lower-earner’s income than that of a higher earner. If you don’t pay into the system for many years — because you’re in a job that provides a government pension instead — your annual earnings for Social Security would be reported as zeros in those years. Social Security is based on your 35 highest-earning years, so all those zeros would make it look like you earned a lower (often much lower) lifetime income than you actually did.

Without any adjustments, you would wind up with a bigger check from Social Security than someone who earned the same income in the private sector and paid much more in Social Security taxes. It was that inequity that caused Congress to create the windfall elimination provision several decades ago.

People who earn government pensions also could wind up with significantly more money when a spouse dies. If a couple receives two Social Security checks, the survivor gets the larger of the two when a spouse dies. The household doesn’t continue to receive both checks.

Without the government pension offset, someone like you would get both a pension and a full survivor’s check. Again, that could leave you significantly better off than someone who had paid more into the system.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.