Q&A: The bottom line on getting your credit scores in better shape

Dear Liz: I want to write a letter of explanation to be included on my credit reports to explain a negative posting. How much impact will the letter have on my credit scores?

Answer: Credit scoring formulas can’t read, so letters of explanation won’t help your scores.

You do have a federal right to demand the credit bureaus include your explanation, which is also known as a consumer statement, in your credit reports. Theoretically, the statement could help a lender understand why you have the negative mark — but only if a human being actually examines your credit report and uses the information in evaluating your creditworthiness.

Because lending is largely automated, however, there’s no guarantee your statement will be read, let alone factored into a lending decision. Many of the other details of your credit report are converted to standardized codes used to calculate credit scores, but not consumer statements.

If the negative information in your reports isn’t accurate, you can dispute it with the credit bureaus. If the information is accurate, you can work to offset the effect on your scores.

Paying your credit accounts on time, all the time, will help rebuild credit. So will using less than 10% of your limits on credit cards.

If you don’t have a credit card, consider getting a secured card — where the credit limit typically is equal to the amount you deposit with the issuing bank. Credit builder loans, available at many credit unions, also can help add positive information to your credit reports.

Don’t close accounts, because that could hurt your scores and won’t get rid of any associated negative information.

People with only a few credit accounts also can help their scores by being added as an authorized user to a responsible person’s credit card. The responsible person doesn’t need to grant access to the actual card. Before taking this step, though, ask the credit card issuer whether authorized user information will be imported to your credit reports because issuers’ policies vary.

Q&A: Side effects of IRA conversions

Dear Liz: I thought your readers would benefit from additional knowledge about Roth conversions. I started converting our IRAs to Roth IRAs when my wife and I turned 60 years old. Years later, I realized that our premiums for Medicare Part B and D were higher because our income in those years exceeded $174,000.

Answer: Triggering Medicare’s income-related monthly adjustment amount (IRMAA) is just one of the potential side effects of a later-in-life Roth conversion.

That’s not to say these conversions are a bad idea.

People with substantial amounts in traditional retirement accounts might benefit from transferring some of that money to Roth IRAs, particularly if the required minimum withdrawals that start at age 72 would push them into a higher tax bracket. They may have a window after they retire, when their tax bracket dips, to convert money and pay the tax bill at a lower rate.

Roths also don’t have the required minimum distributions that apply to other retirement accounts, so people have more control over their future tax bills.

Converting too much, however, can push people into higher tax brackets. Many financial advisors suggest their clients convert just enough to “fill out” their current bracket.

For example, the 12% bracket for married people filing jointly was $19,401 to $78,950 in 2019. A couple with income in the $50,000 range might convert $28,000 or so, because a larger conversion would push them into the 22% tax bracket.

But there are other considerations, as you discovered.

People with modified adjusted incomes above certain levels pay IRMAA adjustments that can add $144.60 to $491.60 each month to their Medicare Part B premiums for doctor visits and $12.20 to $76.40 to their monthly Part D drug coverage premiums. Higher income could reduce or eliminate tax breaks that are subject to income phaseouts, and conversions can subject more of your Social Security benefits to taxation.

At the very least, you should consult a tax pro before any Roth conversions to make sure you understand the ramifications. Ideally, you’d also be talking with a fee-only, fiduciary financial planner to make sure conversions, and your retirement plan in general, make sense.

Q&A: Helping a son with horrible credit scores

Dear Liz: My 33-year-old son has horrible credit scores. If I added his name to my credit card, would it have a positive effect on his score without any negative ramifications to mine? Could any of his creditors come after me?

Answer: Adding someone to your credit card as an authorized user can have a positive effect on their credit scores without negatively affecting your own or obligating you to pay their other debts. You would be responsible for any debt your authorized user incurred on the card.

In your son’s case, though, being added as an authorized user probably won’t help much.

When someone has fallen behind on their bills, the effect on their scores depends on three main factors: recency (how recently did a late payment occur?), severity (how far behind are they — 30 days, 60 days, 90 days or more?) and frequency (how many accounts have late payments?).

One skipped payment can knock 100 points or more off good scores but won’t result in “horrible” credit. Truly bad credit typically requires someone to be well behind on a number of accounts in the recent past. The fact that you’re worried about his creditors indicates that he may not have resolved his financial problems enough to start rebuilding his credit.

What he should do now depends on his circumstances.

If he still has a job, he may be able to arrange a payment plan or settle debts with collectors. If his income has dropped or he’s otherwise unable to pay, he may need to consider bankruptcy.

Once his past debts are resolved — either paid, settled or legally erased — he can take steps to improve his credit, one of which could include being added to your card. A credit builder loan, offered by many credit unions, also could help, as could a secured credit card, which requires a deposit.

It’s crucial that he be able to make all his payments on time, however. If he falls behind again, he’ll offset any progress that’s been made.

Q&A: IRS pays interest on late refunds

Dear Liz: I filed my return electronically with direct deposit. I have yet to receive my refund or that stimulus relief check. We have to pay interest on any late tax payment. Will the IRS pay interest on late refunds?

Answer: The IRS has said it will pay interest on late refunds if the return was filed by July 15, the extended tax deadline. The interest “will generally be paid from April 15, 2020, until the date of the refund,” the IRS says on its site. Don’t expect to get rich: The interest rate for the second quarter, which ended June 30, is 5% a year, while the interest rate for the third quarter, which ends Sept. 30, is 3% a year.

Q&A: IRA conversions and taxes

Dear Liz: You recently advised a reader that if their income was too high to contribute to a Roth IRA, they could still contribute to an IRA or any after-tax options in their 401(k). You didn’t mention a two-step Roth IRA — first making a nondeductible contribution to an IRA and then immediately converting that amount to a Roth. That way those people whose income is too high to contribute to a direct Roth IRA can still have a Roth IRA using the two-step process.

Answer: This is known as a backdoor Roth contribution, which takes advantage of the fact that the income limits that apply to Roth contributions don’t apply to Roth conversions. Conversions, however, typically incur tax bills and don’t make sense for everyone. If you have a substantial amount of pretax money in IRAs, the tax bill can be considerable. (The tax bill is figured using all your IRAs, by the way. You can’t get around it just by contributing to a separate IRA that you then convert.)

Incurring that tax bill could make sense if you expect to be in the same tax bracket in retirement, or in a higher one. If you’re young and a good saver, it’s a good bet that will be the case. Roth conversions also can be advisable later in life if your tax bracket could jump when you reach age 72 and have to start taking required minimum distributions from your retirement accounts.

If you expect to be in a lower tax bracket in retirement, however, you probably should forgo Roth conversions because you’ll pay more now in taxes than you would later.

Of course, if you have little or no pretax money in your IRA, then backdoor conversions get a lot more attractive because the tax bill would be minimal. Otherwise, you should seek out a Roth conversion calculator to get a better idea of whether a conversion might be the right choice.

Q&A: I get different credit scores from my bank and card companies. What gives?

Dear Liz: I have three financial providers that supply regular, free credit scores: my bank and two credit card issuers. My credit score from the bank is always a “perfect score” while the two card companies are consistently 17 points lower, both exactly the same for two years now. I always pay off most or all of the outstanding balance on time or early. Any clue as to why there is this consistent difference?

Answer: The companies probably are using different credit scoring formulas or different credit bureaus, or both.

You don’t have one credit score. You have many. FICO is the dominant scoring formula, but lenders also use VantageScores and the credit bureaus sometimes provide their own, proprietary scores.

The formulas have been updated over the years. The FICO 8 is the most commonly used score, but the FICO 9 is the latest version and FICO 10 will be introduced this summer. Some scoring formulas are modified to suit different industries, such as auto lending or credit cards, plus each score is calculated from data at one of the three credit bureaus.

So one institution may provide its customers a FICO Score 9 from Experian, another might offer a FICO 8 Bankcard score from Equifax and a third might give you a VantageScore 3.0 from TransUnion. Even if all three were using the same type of score, they probably would use different credit bureaus, or vice versa. To make things even more confusing, your credit scores are constantly changing as your credit bureau information changes.

Furthermore, you typically can’t predict which score or scores a lender will use to evaluate your application for credit. Rather than worry about which number is “right” — they all are — use the free scores as a general indicator of your credit health.

Q&A: Retirement accounts and taxes

Dear Liz: I am 41 and have had a traditional IRA for about two decades. I funded it for the first 10 years, taking a tax deduction for the contributions. Since I’ve had a 401(k) with my employer for the past several years, I obviously cannot take a deduction for the IRA amount, but I could still put money in. My 401(k) is fully funded, as is my husband’s. Does it make sense to also fund our IRAs with post-tax, nondeductible amounts? I realize any gains we make will be taxed at withdrawal, but I also know that as long as the money stays in the IRA, it can grow tax deferred.

Answer: First, congratulations on taking full advantage of your workplace retirement plans and still being able to contribute more.

You potentially can deduct contributions to IRAs when you have a 401(k) or other workplace retirement plan, but your income must be below certain limits. You can take a full deduction if your modified adjusted gross income is $104,000 or less as a married couple filing jointly. After that, the ability to deduct the contribution starts to phase out and is eliminated entirely if your modified adjusted gross income is $124,000 or more. (If you don’t have a workplace retirement plan but your spouse does, the income limits are higher. The deduction starts to phase out at $196,000 and ends at $206,000.)

If you can’t deduct contributions, you can look into contributing to a Roth IRA — but that too has income limits. For a married couple filing jointly, the ability to contribute to a Roth begins to phase out at modified adjusted gross income of $196,000 and ends at $206,000. If you can contribute, it’s a good deal. Roth IRAs don’t offer an upfront tax break but withdrawals in retirement can be tax free. You also can leave the money alone for as long as you want — there are no required minimum withdrawals starting at age 72, as there typically are for other retirement accounts.

If your income is too high to contribute to a Roth, you could still contribute to your IRA or to any “after tax” options in your 401(k). But you might want to consider simply investing through a regular taxable brokerage account. You don’t get an upfront tax deduction but you could still benefit from favorable capital gains tax rates if you hold investments for a year or more. Furthermore, you aren’t required to take withdrawals. That flexibility can help you better manage your tax bill in retirement.

Q&A: But not for this octogenarian

Dear Liz: I am 81 and opened a Roth IRA before retiring 15 years ago, but have not added to that account since. Recently I realized a cash windfall and would like, if possible, to deposit that money in my existing Roth IRA, but I am confused about the limitations and rules on doing so. My current income is from interest, Social Security, a small pension and 401(k) withdrawals. Can you help me with the applicable rules that would govern additions to a Roth IRA in my situation, and can I do so?

Answer: Retirement account rules can be complicated in some respects, but not in this particular case. If you don’t have earned income — such as wages, salaries, bonuses, commissions, tips or net earnings from self-employment — you can’t contribute to an IRA or a Roth IRA.

Q&A: Retirement accounts for teenagers

Dear Liz: My 16-year-old grandson has a job stocking shelves at a large grocery chain. His parents opened a low-cost minors investment account, which he has now funded to the max of $6,000. Is there anywhere else he can invest his earnings?

Answer: It sounds like what your grandson funded was an IRA or a Roth IRA. These retirement accounts have an annual $6,000 contribution limit for people under 50. (People 50 and older can make an additional $1,000 “catch up” contribution.) The Roth IRA has income limits, but your grandson won’t have to worry about those until he earns more than six figures.

Starting to save so young for retirement is a marvelous idea, since all those decades of compounded returns will really add up. Let’s assume two people save $6,000 a year and earn a 7% average annual return. The person who starts saving at age 36 would accumulate about $650,000 at age 66. The person who starts at age 16, by contrast, would have about $2.5 million.

Your grandson’s parents were smart to open a low-cost account, presumably at a discount brokerage. Next to starting early and investing as much as possible, keeping fees low is the best way to maximize how much he ultimately accumulates.

The simplest way to start investing would be to choose a low-cost target date mutual fund. He would choose one with a date closest to his likely retirement age, so one that’s labeled something like “Target Date 2070.” If you want to encourage him to learn more, consider buying him a book about investing, such as “O.M.G.: Official Money Guide for Teenagers” by Susan and Michael Beacham.

Q&A: The case for filing a tax return

Dear Liz: A couple on Social Security who hadn’t received their stimulus payments wrote that they “do not make enough income to file tax returns.” It might be worthwhile to let your readers know that, even if one’s income is below the amount where they must file a tax return, they nevertheless may file a tax return. I volunteer at a site where we do free tax preparation, and we encourage filing even when not required. It can help identify or potentially prevent identity theft, and it provides documentation of tax status that may be helpful in the future.

Answer: Thanks for that tip. People receiving Social Security weren’t required to file tax returns to receive their stimulus payments of up to $1,200 each, but as you noted there can be other advantages to filing even when it’s not necessary.

Most stimulus payments have been delivered at this point, although a congressional committee estimated 30 million to 35 million had not been sent. If you got a letter saying your payment had been sent, but you haven’t received the money, you can ask the IRS to trace your payment by calling (800) 919-9835.