Ask Liz Weston

Get smart with your money

q&a

Q&A: Should a soon-to-be retiree use savings to pay off the mortgage?

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Dear Liz: I am 64, single and planning to retire in two years. I have saved enough to pay off my $100,000 mortgage. It will take the bulk of my savings but I have no other debts. I will have a pension and Social Security. I also have a credit score over 800. Should I do this?

Answer: Being debt free in retirement is wonderful, but being stuck short of cash is not. It’s a particularly bad idea to use pretax money from retirement accounts to pay off a mortgage. Not only can the withdrawal trigger a big tax bill, but it may push you into a higher tax bracket for that year and cause other unexpected tax consequences.

Even if your pension and Social Security cover your expenses now, that probably won’t be the case for the rest of your life. For example, Medicare covers about half of the typical retiree’s medical costs, and doesn’t pay at all for most long-term care expenses if you should need those.

You could pay off the mortgage and then arrange a home equity line of credit you could tap for such expenses or for emergencies. Just be aware that lenders can freeze or close lines of credit at their discretion, so it won’t be the same as having cash on hand.

Decisions made about retirement are complex and often irreversible. Consider consulting with a fee-only financial planner about your retirement plans so you better understand your options and the consequences of the choices you’re making.

Q&A: Figuring the tax toll for an inherited house

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Dear Liz: I inherited my home when my husband died. If I sell this house now at a current market value of around $900,000, what will be the basis of the capital gains tax? I think at the time of my husband’s death, the house’s market value was $400,000.

Answer: Based on your phrasing, we’ll assume your husband was the home’s sole owner when he died. In that case, the home got a new value for tax purposes of $400,000. That tax basis would be increased by the cost of any improvements you made while you owned it. When you sell, you subtract your basis from the sale price, minus the costs to sell the home, such as the real estate agent’s commission, to determine your gain. You can exempt up to $250,000 of the gain from taxation if it’s your primary residence and you’ve lived in the house at least two of the previous five years. You would owe capital gains taxes on the remaining profit.

Here’s how the math might work. Let’s say you made $50,000 in improvements to the home, raising your tax basis to $450,000. You pay your real estate agent a 6% commission on the $900,000 sale, or $54,000. The net sale price is then $846,000, from which you subtract $450,000 to get a gain of $396,000. If you meet the requirements for the home sale exclusion, you can subtract $250,000 from that amount, leaving $146,000 as the taxable gain.

If your husband was not the sole owner — if you owned the home together when he died — the tax treatment essentially would be the same if you lived in a community property state such as California. In other states, only his share of the home would receive the step-up in tax basis and you would retain the original tax basis for your share.

Q&A: Self insurance brings risk

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Dear Liz: A letter writer in your column says that “self insurance,” or going without health insurance, “certainly reinforces healthy lifestyle choices.” My husband made all of those “right” choices for more than 60 years, which was absolutely no protection against being diagnosed with brain cancer. Your penny-pinching correspondent might currently be running marathons or doing daily yoga, but as Clint Eastwood put it: “You’ve gotta ask yourself one question: ‘Do I feel lucky? Well, do ya, punk?’”

Answer: As a nation, we could certainly lower our healthcare costs by choosing healthier lifestyles — exercising, avoiding obesity, not smoking and so on. But accident or illness can strike even the healthiest among us, which is why health insurance is a necessity not just to ensure we can get care but to protect against catastrophic medical bills.

Unfortunately, as human beings we often have the delusion that what’s happened in the recent past will continue indefinitely. If we’ve been lucky with our health, we may think that will always be the case. The reality is that everybody’s luck runs out at some point, and often does so at great expense.

Q&A: Mother-daughter drama and the financial ties that bind

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Dear Liz: My mother is turning 92 this month. Due to a dispute, my mother amended her will last year and stated that my inheritance had to be used for a certain purpose.

My brother sent me the amendment and told me he will enforce my mother’s wishes. He also told me that I had to send a letter to him after my mother dies if I do not want anything from her trust. Is this accurate?

I want to put it in writing before my mother dies that I do not want a penny from her trust. I want to be completely estranged from my family and their control. Do I need a lawyer to do this, and do I have to wait until her death to put this in writing?

Answer: Consider showing the email to an experienced estate planning attorney to find out how much actual control your mother will have from beyond the grave. There may be workarounds that you (and your mother) haven’t considered.

If you decide you don’t want the money after her death, you can “disclaim” it in the letter your brother described. While it may seem more satisfying to make the point while your mother is still alive, you cannot force her to disinherit you any more than she can force you to take the money if you don’t want it.

Q&A: Going without health insurance isn’t wise

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Dear Liz: You recently wrote about early retirees going abroad for their pre-Medicare years in order to get more affordable healthcare coverage. Why did you not bother to even mention the COBRA option that is often available to workers upon retirement? And by the way, some of us prefer to self-insure in our pre-Medicare years and even opt to not buy Part B coverage once we were eligible. Self-insuring is not for the sick, only the healthy, but there is a place for this never-mentioned option and it certainly reinforces healthy lifestyle choices.

Answer: COBRA was mentioned as an option in the original column, which addressed the retirement concerns of a woman 10 years younger than her husband. COBRA allows employees to continue their healthcare coverage for up to 18 months, so someone who is 63½ could use COBRA to bridge the gap until Medicare.

The coverage isn’t cheap because the retiree will have to pay the full premium without the employer subsidy, plus a 2% administrative fee. Anyone retiring earlier than 63½, including the younger spouse in the original column, still could face years without coverage once COBRA is exhausted.

And going without health insurance isn’t wise. Regardless of how healthy you currently happen to be, you’re one serious accident or illness away from disaster. Self-insuring can make sense for the smaller ongoing expenses of primary care. At a minimum, though, people should have a high-deductible plan that protects them from catastrophically high medical bills.

The decision to forgo Part B of Medicare may be an expensive one, as well. (For those who don’t know, Part A of Medicare is free for beneficiaries and covers hospital visits. Part B covers doctor visits, preventative care and medical equipment, among other expenses, and requires paying a monthly premium. Most people pay $134 a month for Part B coverage, although singles with incomes over $85,000 and married people with incomes over $170,000 pay higher amounts.) A permanent 10% penalty is tacked on to monthly premiums for every 12 months you were eligible for Part B but didn’t sign up.

Q&A: One spouse’s debts might haunt the other after death

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Dear Liz: I have a terminal illness and have less than a year to live. My wife and I are in our 80s and don’t own anything: no cars, no homes. My wife has an IRA worth $140,000 that pays us $2,000 a month, and she has a small pension of $1,400 a month. We receive $3,900 from Social Security, for a total monthly income of $7,200.

We have $72,000 in credit card debt that is strangling us. I told my wife that after I’m gone she should simply ignore that debt and advise creditors that I have passed away. Or should we attempt to file bankruptcy now?

Answer: Your return address shows you live in California, which is a community property state. Debts incurred during marriage are generally considered joint debts, so expecting creditors to go away after your death is not realistic.

Your wife’s retirement also could be at risk because California has limited creditor protection for IRAs. Federal law protects IRAs worth up to $1,283,025 in bankruptcy court, but outside bankruptcy, creditor protection depends on state law. In California, only amounts “necessary for support” are protected.

You really need to consult with a bankruptcy attorney to discuss your options. You can get referrals from the National Assn. of Consumer Bankruptcy Attorneys at www.nacba.org.