April 17, 2017 By

Q&A: Capital gains tax on home sale profit

Dear Liz: I recently sold a home and am trying to escape the dreaded capital gains tax. I’ve done everything I can to reduce my overall tax bill, including maxing out my retirement contributions. I don’t want to buy a more expensive home to escape the gains tax. Any thoughts?

Answer: Buying a more expensive home wouldn’t change what you owe on your previous home. The days when you could roll gains from one home purchase into another are long gone.

These days you’re allowed to exclude up to $250,000 in home sale profit from your income (the limit is per person, so a couple can shelter $500,000). In other words, that amount is tax free, as long as you lived in the home for at least two of the previous five years. Beyond that your profit is subject to capital gains taxes. The top federal capital gains rate is 20%, plus a 3.8% investment surtax if your income is more than $200,000 for singles or $250,000 for married couples.

Here’s where good record-keeping may help. While generally you’re not allowed to deduct repair and maintenance costs from that profit, you can use home improvement expenditures to reduce the tax you owe. Home improvements are added to your cost basis — essentially what you paid for the property, including settlement fees and closing costs, and that’s what is deducted from your net sales price to determine your profit.

You’ll need receipts plus credit card or bank statements to prove what you paid. Improvements must “add to the value of your home, prolong its useful life, or adapt it to new uses,” according to IRS Publication 523, Selling Your Home. Examples of improvements include additions, remodels, landscaping and new systems, such as new heating or air conditioning systems. You can include repairs that are part of a larger remodeling job, but you can’t include improvements you later take out (such as the cost of a first kitchen remodel after you do a second one).

Filed Under: Q&A, Real Estate, Taxes Tagged With: , ,
April 10, 2017 By

Q&A: What to do about heavy credit card debt

Dear Liz: I have a lot of credit card debt and am just able to make minimum payments. I feel like after doing this for four years now that I am not getting ahead. I will be 61 this summer and don’t have much saved for retirement. My rent keeps going up along with other expenses. I have an 11-year-old car that is in need of maintenance but don’t have the funds to do it. My question is, what would happen if I walk away from the credit card debt? Will I be facing garnishment?

Answer: Yes, you could be sued and face wage garnishment if you simply stopped paying your debts.

You could consider a debt management plan offered through a credit counselor, which could lower the interest rates you pay. You can get referrals from the National Foundation for Credit Counseling at www.nfcc.org. But you’d be making payments for the next five years or so, when you could be putting that cash toward your retirement.

A Chapter 7 bankruptcy, by contrast, would take a few months and legally erase your credit card debt to give you a fresh start. Bankruptcy is often the best of bad options when you can’t make progress on your debts. Consider meeting with both a credit counselor and a bankruptcy attorney so you understand all your options.

Filed Under: Credit & Debt, Credit Cards, Q&A, Uncategorized Tagged With: , , ,
April 10, 2017 By

Q&A: Parking money for a short term

Dear Liz: We will soon be selling our home and moving into an apartment until we purchase a new home. Our proceeds from the sale will be over $600,000. It seems that there is no place to safely put the funds and get some meaningful interest to boot. Savings accounts and money markets pay very little interest, and certificates of deposit have a fixed time. We may need to withdraw the money in as few as 30 days, but it may be six months or longer. Any suggestions where to park our money?

Answer: Some online banks currently offer interest rates around 1% for savings accounts. It’s not much, but it’s better than the 0.06% rate that’s currently the national average, according to the FDIC’s April 3 report. An Internet search for “best savings rates” should turn up competitive offers.

A rate of 1% isn’t much and means that you’ll lose a little ground to inflation, which is currently more than 2%. But it’s more important that your money be safe and liquid, ready when you need it, than for you to try to squeeze a high return from it.

Filed Under: Banking, Q&A, Real Estate Tagged With: , , ,
April 10, 2017 By

Q&A: Professional investment management fees

Dear Liz: I have an IRA with over $100,000 at a discount brokerage. I had it in a target date fund. Due to market downturns, I got nervous and was convinced to put my investment into the brokerage’s portfolio advisory services with additional fees coming to $1,600 per year. In general, is it wise to change investments to these more professional services?

Answer: If professional management keeps you from bailing out of your investments when markets decline, then paying a higher fee may be justified. But the higher the fees you pay, the less money you can accumulate. For example, your IRA could grow to more than $600,000 over 30 years if you net a 6% return. If your fees are one percentage point higher, and you net just 5%, you’d end up with less than $450,000.

Some discount brokers, including Schwab, Fidelity and Vanguard, now offer a low-cost “robo” option that invests your money using computer algorithms. These robo options don’t offer the highly customized investment portfolios that some other services provide, but they come at a much lower cost — typically 0.3% to 0.4%. A few, including Vanguard and Betterment, offer access to financial advisors.

Filed Under: Uncategorized Tagged With: , , ,
April 10, 2017 By

Q&A: Annuities have indirect costs

Dear Liz: Thank for your right-on reply to the reader who claimed that fixed and indexed annuities were available at no cost to investors. I am so tired of hearing from agents and investors that their annuity is great and does not have fees!

Answer: Insurance companies aren’t charities providing investments at no cost. They’re businesses that have to keep the lights on and pay the people who sell their products. With fixed and indexed annuities, the cost is built into the interest rate spread, which is the difference between what the insurer earns on your money and what it pays into your account. The investor pays an indirect cost, rather than a direct cost that’s explicitly disclosed.

Filed Under: Annuities, Q&A Tagged With: ,
April 3, 2017 By

Q&A: Credits can boost a refund beyond the taxes paid — and keep millions out of poverty

Dear Liz: A friend of mine received a 2016 tax refund of over $9,000 even though this person did not pay nearly that amount in taxes over the course of the year. My friend has a fairly low-paying job with no benefits, is a single parent of two young children and receives no support from the children’s other parent. Given this scenario, is it possible to get a tax refund in an amount greater than what you paid in taxes?

Answer: Absolutely, and these refundable credits keep millions of working Americans out of poverty each year.

Refundable credits are tax breaks that don’t just offset taxes you owe but also can give you additional money back. Most of your friend’s refund probably came from the earned income tax credit, which was initially created in the 1970s to help low-income workers offset Social Security taxes and rising food costs due to inflation.

The credit was expanded during President Reagan’s administration as a way to make work more attractive than welfare. Each administration since has increased the credit, which has broad bipartisan support.

The maximum credit in 2016 was $506 for a childless worker and $6,269 for earners with three or more children. Your friend probably also received child tax credits of up to $1,000 per child. This credit, meant to offset the costs of raising children, is also at least partially refundable when people work and earn more than $3,000.

Filed Under: Q&A, Taxes Tagged With: , , , ,
April 3, 2017 By

Q&A: Investment advisor’s fees

Dear Liz: Two years ago I rolled my 401(k) into an IRA at the suggestion of an advisor after I lost my job. The rollover was $383,000, and a secondary amount of $63,000 was transferred from my after-tax savings to a second account. All the fees for the advisor are taken from my small account and are 1.5% annually. My IRA is now at $408,000. Assuming an average earnings of 3% annually ($12,000), and with the advisor taking 1.5% ($6,000), I’m thinking this is not beneficial to me financially and that can I do better. Also, why is the advisor taking his fee out of my small (after-tax) account? I am 67 and filed for full Social Security in January.

Answer: You should ask your advisor to confirm this, but withdrawals from the smaller account are likely to trigger a smaller tax bill since most of the money there has already been taxed. A withdrawal from your larger account, which is presumably all pre-tax money, would result in a larger tax bill for you.

That’s the end of the good news. Given your age, with perhaps decades of retirement ahead, a good benchmark for you to use to compare your returns would be Vanguard’s Balanced Composite Index, which tracks the performance of funds that have 60% of their portfolios in stocks and 40% in bonds. The index returned 8.89% in 2016 and has a three-year average of 6.49%. Even a portfolio with a much lower proportion of stocks would have gotten better results than you did. Vanguard’s Target Retirement 2015 fund, with a stock exposure of less than 30%, earned 6.16% last year and 4.04% on average over the last three years.

Investment performance shouldn’t be the only way you judge an advisor, but giving up half your returns to fees could dramatically reduce the amount you have to live on in retirement.

Fortunately, you have options. You could hire a fee-only planner who charges by the hour to design a portfolio for you, and implement it yourself at one of the discount brokerage firms such as Schwab, Vanguard, Fidelity or T. Rowe Price.

Or you could explore the digital investment options known as robo-advisors, which invest and rebalance your money using computer algorithms. Some of the pioneers in this field include Betterment, Wealthfront and Personal Capital. Schwab, Vanguard and T. Rowe Price also offer digital investment services directly to consumers, while Fidelity offers it to advisors.

If you still want the human touch, some of the services — including Betterment, Personal Capital, Vanguard and T. Rowe Price — combine digital investment with access to advisors.

Filed Under: Investing, Q&A Tagged With: , ,
March 27, 2017 By

Q&A: The old magazine scam is alive and well. Here’s how to fight back

Dear Liz: I got scammed by a magazine company a year ago. I thought the call was about two magazines I wanted to stop as I was moving. The woman talked fast and took me through the steps with my bank card (which was stupid of me, I now know) as if she was helping and at the end she said, “Oh, those are not our magazines.” Two weeks later I was receiving about eight magazines I do not want. I changed my bank card so the withdrawals would stop, but I get so many collection calls. I hang up and block that number, but then I get more. My bank manager said consumers don’t have to pay for what they don’t want. I have told the collectors that, but they still send bills for $1,200 for three years of magazines.

Answer: Don’t expect collectors for scam artists to help you out. Amy Nofziger, regional director for the AARP Foundation, recommends you contact your state’s attorney general to file a complaint.

“Magazine subscriptions like this are still a huge complaint and the AGs need to know about it, so they [can] file enforcement against the company if needed,” Nofziger said.

You must follow certain procedures to request that the debt collection agency stop contacting you. The AG’s office may be able to help or there may be a separate collection agency board you need to contact. The Federal Trade Commission also has guidance at www.consumer.ftc.gov/articles/0149-debt-collection.

You also can call and speak to a trained volunteer at the AARP Fraud Watch Network who can help you through the steps. Its number is (877) 908-3360 and you can learn more at www.aarp.org/FraudWatchNetwork.

Filed Under: Q&A, Scams Tagged With: , ,
March 27, 2017 By

Q&A: Annuities and fees

Dear Liz: I must object to a point you made in a recent column. You wrote: “…Also, annuities often have high fees, so you’d need to shop carefully and understand how the surrender charges work.” To write “…annuities often have high fees” is misleading, because there are annuities that don’t have fees, such as fixed annuities and indexed annuities. Coupling that phrase about fees with the admonition “you’d need to shop carefully and understand how the surrender charges work” is also a disservice to the public. Of course, an investor has to understand surrender charges! Just like if they try to end a bank CD too soon, there’s a penalty, or if they try to get out of a real estate deal incorrectly, or if they commit some other kind of breach of contract. That doesn’t mean that annuities are bad investments, especially when their principal is guaranteed, and no fees to pay.

Answer: Thanks for bringing up two areas of confusion that are actually linked.

All investments have costs. Many, including mutual funds and variable annuities, explicitly state their fees. With fixed and indexed annuities, the cost isn’t disclosed. Instead, it’s built into the interest rate spread — the difference between what the insurer earns on your money and what it pays into your account, said financial planner Michael Kitces, partner and director of financial planning research at Pinnacle Advisory Group in Columbia, Md.

“In other words, if the annuity company pays 2.5% on its annuity, it likely earned closer to 3% or 3.5% in the first place,” Kitces said. The insurer keeps the remainder to recover commissions paid to the insurance agent and the annuity’s own profit margins, he said.

Indexed annuities are a little more complicated. These promise investors they will get a certain portion of the return earned by some market benchmark while protecting them from market losses. The insurers use the spread to cover their overhead costs, profits and commissions. But instead of paying the remaining yield into your account, insurers use the money to purchase options that provide the promised participation rate in the index, said Kitces, who writes the Nerd’s Eye View blog at kitces.com.

Either way, surrender charges encourage people to stay invested long enough for the insurance company to get back enough money from the interest rate spread to cover the cost of commissions. If people need their money during the first few years, the surrender charge they pay is designed to make up the difference between what the insurer paid out and what it has received from the yield spread. Surrender charges are typically around 7% to 9% and may persist for seven or more years, although the penalty declines over time.

You’ve heard that “there’s no such thing as a free lunch.” Investors need to understand that they’re paying a price for their investments, even if they can’t see the money directly coming out of their pockets. Costs are a drag on investor returns and how big their portfolios can grow. That’s why it’s important to minimize those costs. When insurers don’t disclose the costs, it’s hard to know how much you’re giving up compared to what you could earn from another investment.

Filed Under: Investing, Q&A Tagged With: ,
March 20, 2017 By

Q&A: Deploying a windfall wisely

Dear Liz: I recently received a $38,000 windfall. I have a student loan balance of $37,000. I want to buy a home, but I can’t decide if I should have a large down payment and continue paying down student loans slowly, or make a balloon payment on my student loans and put down a smaller amount on the home. The mortgage rate would be around 4% while the student loans are at 6.55%. The price of homes in my area is at least $250,000 for a two-bedroom house (which my income supports). I want to make a smart decision.

Answer: At first glance, the answer may seem obvious: Pay down the higher-rate debt. But a deeper look reveals that the second option may be the better course.

Student loan interest is deductible, so your effective interest rate on those loans may be less than 5%. If they’re federal student loans, they have all kinds of consumer protections as well. If you lose your job, for example, you have access to deferral and forbearance as well as income-sensitive repayment plans. In most cases, you don’t need to be in a rush to pay off this tax-advantaged, relatively low-rate debt.

A home purchase may be more time sensitive. Interest rates are already up from their recent lows and may go higher. If you can afford to buy a home and plan to stay put for several years, then you probably shouldn’t delay.

A 10% down payment should be sufficient to get a good loan. You’ll have to pay private mortgage insurance, since you can’t put 20% down, but PMI typically drops off after you’ve built enough equity. You usually can request that PMI be dropped once you’ve paid the mortgage down to 80% of the home’s original value. At 78%, the lender may be required to remove PMI. (Note that these rules apply to conventional mortgages and don’t apply to the mortgage insurance that comes with FHA loans.)

You can use the remaining cash to pay down your student loans, but do so only if you already have a healthy emergency fund. It’s smart to set aside at least 1% of the value of your home each year to cover repairs and maintenance, plus you’ll want at least three months’ worth of mortgage payments in the bank. Even better would be enough cash to cover all your expenses for three months.

Filed Under: Q&A, Real Estate, Student Loans Tagged With: , , ,