News, Retirement

Here’s How to Find Out How Much Social Security Income You’ll Receive

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At what age will you retire? How much can you expect to receive each month when you do? These are important questions even if you are decades away from retirement, and there’s an easy way to get answers anytime. We’re going to show you how to get your Social Security benefits statement online and what to do with it once you’ve got it.

A little background:

Depending on your age, you may remember getting a printed Social Security benefits statement in the mail. Prior to 2011, the Social Security Administration (SSA) mailed statements to all workers every year. Those annual mailings were discontinued in 2011 as a cost-saving measure. The following year, the SSA made the statements available online, but their decision caused a bit of an uproar. Despite the agency’s outreach campaign, far fewer people registered for an account than there were eligible workers. So in 2014, Congress required the agency to resume sending printed statements every five years to workers age 25 and older who hadn’t registered for an online account.

That schedule remained until earlier this year when the agency announced that due to budget restraints, paper benefit statements will only be mailed to people who are 60 or older, have not established an online account, and are not yet receiving Social Security benefits. Simply put, don’t expect to get a printed statement anytime soon.

How to get your Social Security benefits statement

Accessing your Social Security benefits statement online is pretty simple, as long as you have an email address and can provide some basic identifying information.

First, go to ssa.gov/myaccount and click on “Sign In or Create an Account.”

If you’ve never created an online account with the SSA, you’ll click on “Create an Account.” If you’ve set up an account before, you won’t be able to create a new account using the same Social Security number. If you’ve forgotten your username or password, the SSA website offers tools to help recover them.

When you select “Create an Account,” the site will lead you through a few questions to verify your identity. You’ll need to provide personal information that matches the information on file with the SSA as well as some information matching your credit report.

Ryder Taff, a Certified Financial Adviser with New Perspectives, Inc. of Ridgeland, Miss., helps many of his clients set up Social Security accounts and says the questions often have to do with past residences or vehicles that may have been registered in your name.

If you have trouble setting up your account online, you can call the SSA for help at 1-800-772-1213.

Information in a Social Security benefits statement

Your Social Security benefits statement provides several valuable pieces of information:

  • A record of your earnings, by year, since you began having Social Security and Medicare taxes withheld.
  • Estimated retirement benefits if you begin claiming Social Security at age 62, full retirement age, or age 70.
  • Estimated disability benefits if you became disabled right now.
  • Estimated survivor benefits that your spouse or child would receive if you were to die this year.

Here’s a sample of what your benefits statement will look like:

Keep in mind that the estimated benefits shown are just that — estimates. The amounts shown are calculated based on average earnings over your lifetime and assume you’ll continue earning your most recent annual wages until you start receiving benefits. They are also calculated in today’s dollars without any adjustment for inflation. The amount you receive could also be impacted by any changes enacted by Congress from now until the time you retire.

What to do with your Social Security benefit statement

It’s a good idea to check your earnings record for errors once per year. It’s not uncommon for earnings from certain employers or even all of your earnings from an entire year to be missing, and you’ll want to get that corrected right away because benefits are calculated on your highest 35 years of earnings. “Any missing years will be just as damaging as a zero on a test was to your GPA,” Taff says. “Gather your documents and correct ANY missing years, even if they aren’t the highest salary. Every dollar counts!”

If you do spot any errors, grab your W-2 or tax return for the year in question and call the SSA at 1-800-772-1213. You can also report errors by writing to the SSA at:

Social Security Agency
Office of Earnings Operations
P.O. Box 33026
Baltimore, MD 21290-3026

Reading your statement is also a good reminder of how much you need to save for retirement outside of Social Security. Chances are, you won’t be happy living on just your Social Security income in retirement.

The good news is, the longer you delay taking your benefit, the higher your annual benefit will be. You can begin taking Social Security retirement benefits at age 62, but your payments will be smaller than they would be if you waited until full retirement age (FRA). Currently, your annual benefit increases by 8% for each year you delay taking your benefit from FRA until age 70.

Colin Exelby, president and founder of Celestial Wealth Management in Towson, Md., says that using your Social Security benefits statement can be particularly useful for retirement planning for couples. “Depending on your age, health, family health history, and financial situation there are a number of different ways to claim your benefits,” he says. “Each individual situation is different, and many couples have different views on the decision.”

If you are nearing retirement, you can use your benefits statement to work with a financial adviser to help you maximize total benefits, or run through various scenarios using a free online tool like the one provided by AARP.

Setting up your Social Security account is simple, free, and helpful for retirement planning, but it’s also a good security measure. It’s impossible to set up more than one account per Social Security number, so registering your account is a good way to prevent identity thieves from establishing an account on your behalf.

Take the time to set up your Social Security account and find out how much you might be entitled to receive in benefits. It could help you feel more empowered to take charge of your retirement plan.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Mortgage, Pay Down My Debt

Should You Use a Mortgage to Refinance Student Loans?

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Fannie Mae, the largest backer of mortgage credit in America, recently made it a little easier for homeowners to refinance their student loans. In an update to its Selling Guide, the mortgage giant introduced a student loan cash-out refinance feature, permitting originators that sell loans to Fannie Mae to offer a new refinance option for paying off one or more student loans.

That means you could potentially use a mortgage refi to consolidate your student loan debt. Student loan mortgage refis are relatively new. Fannie Mae and SoFi, an alternative lender that offers both student loans and mortgages, announced a pilot program for cash-out refinancing of student loans in November 2016. This new program is an expansion of that option, which was previously available only to SoFi customers.

Amy Jurek, a Realtor at RE/MAX Advantage Plus in Minneapolis/St. Paul, Minn., says people with home equity have always had a cash-out option, but it typically came with extra fees and higher interest rates. Jurek says the new program eliminates the extra fees and allows borrowers to refinance at lower mortgage interest rates. The policy change could allow homeowners to save a significant amount of money because interest rates on mortgages are typically much lower than those for student loans, especially private student loans and PLUS loans.

But is it a good idea?

Your student debt isn’t eliminated; it’s added to your mortgage loan.

This may be stating the obvious, but swapping mortgage debt for student loan debt doesn’t reduce your debt; it just trades one form of debt (student loan) for another (mortgage).

Brian Benham, president of Benham Advisory Group in Indianapolis, Ind., says refinancing student loans with a mortgage could be more appealing to borrowers with private student loans rather than federal student loans.

Although mortgage rates are on the rise, they are still at near-historic lows, hovering around 4%. Federal student loans are near the same levels. But private student loans can range anywhere from 3.9% up to near 13%. “If you’re at the upper end of the spectrum, refinancing may help you lower your rate and your monthly payments,” Benham says.

So, the first thing anyone considering using a mortgage to refinance student loans should consider is whether you will, in fact, get a lower interest rate. Even with a lower rate, it’s wise to consider whether you’ll save money over the long term. You may pay a lower rate but over a longer term. The standard student loan repayment plan is 10 years, and most mortgages are 30-year loans. Refinancing could save you money today, but result in more interest paid over time, so keep the big picture in mind.

You need to actually have equity in your home.

To be eligible for the cash-out refinance option, you must have a loan-to-value ratio of no more than 80%, and the cash-out must entirely pay off one or more of your student loans. That means you’ve got to have enough equity in your home to cover your entire student loan balance and still leave 20% of your home’s value that isn’t being borrowed against. That can be tough for newer homeowners who haven’t owned the home long enough to build up substantial equity.

To illustrate, say your home is valued at $100,000, your current mortgage balance is $60,000, and you have one student loan with a balance of $20,000. When you refinance your existing mortgage and student loan, the new loan amount would be $80,000. That scenario meets the 80% loan-to-value ratio, but if your existing mortgage or student loan balances were higher, you would not be eligible.

You’ll lose certain options.

Depending on the type of student loan you have, you could end up losing valuable benefits if you refinance student loans with a mortgage.

Income-driven repayment options

Federal student loan borrowers may be eligible for income-driven repayment plans that can help keep loan payments affordable with payment caps based on income and family size. Income-based repayment plans also forgive remaining debt, if any, after 25 years of qualifying payments. These programs can help borrowers avoid default – and preserve their credit – during periods of unemployment or other financial hardships.

Student loan forgiveness

In certain situations, employees in public service jobs can have their student loans forgiven. A percentage of the student loan is forgiven or discharged for each year of service completed, depending on the type of work performed. Private student loans don’t offer forgiveness, but if you have federal student loans and work as a teacher or in public service, including a military, nonprofit, or government job, you may be eligible for a variety of government programs that are not available when your student loan has been refinanced with a mortgage.

Economic hardship deferments and forbearances

Some federal student loan borrowers may be eligible for deferment or forbearance, allowing them to temporarily stop making student loan payments or temporarily reduce the amount they must pay. These programs can help avoid loan default in the event of job loss or other financial hardships and during service in the Peace Corps or military.

Borrowers may also be eligible for deferment if they decide to go back to school. Enrollment in a college or career school could qualify a student loan for deferment. Some mortgage lenders have loss mitigation programs to assist you if you experience a temporary reduction in income or other financial hardship, but eligibility varies by lender and is typically not available for homeowners returning to school.

You could lose out on tax benefits.

Traditional wisdom favors mortgage debt over other kinds of debt because mortgage debt is tax deductible. But to take advantage of that mortgage interest deduction on your taxes, you must itemize. In today’s low-interest rate environment, most taxpayers receive greater benefits from the standard deduction. As a reminder, taxpayers can choose to itemize deductions or take the standard deduction. According to the Tax Foundation, 68.5% of households choose to take the standard deduction, which means they receive no tax benefit from paying mortgage interest.

On the other hand, the student loan interest deduction allows taxpayers to deduct up to $2,500 in interest on federal and private student loans. Because it’s an “above-the-line” deduction, you can claim it even if you don’t itemize. It also reduces your Adjusted Gross Income (AGI), which could expand the availability of other tax benefits.

You could lose your home.

Unlike student debt, a mortgage is secured by collateral: your home. If you default on the mortgage, your lender ultimately has the right to foreclose on your home. Defaulting on student loans may ruin your credit, but at least you won’t lose the roof over your head.

Refinancing student loans with a mortgage could be an attractive option for homeowners with a stable career and secure income, but anyone with financial concerns should be careful about putting their home at risk. “Your home is a valuable asset,” Benham says, “so be sure to factor that in before cashing it out.” Cashing out your home equity puts you at risk of carrying a mortgage into retirement. If you do take this option, set up a plan and a budget so you can pay off your mortgage before you retire.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Featured, News, Tax

File Taxes Jointly or Separately: What to Do When You’re Married with Student Loans

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Married couples with student loans must make a difficult decision when they file their tax returns. They can choose to file jointly, which often leads to a lower tax bill. Or they can file separately, which may result in a higher tax bill, but smaller student loan payments. So which decision will save the most money?

First, let’s discuss the difference between the two filing statuses available to married couples.

Married filing jointly

Married couples always have the option to file jointly. In most cases, this filing status results in a lower tax bill. The IRS strongly encourages couples to file joint returns by extending several tax breaks to joint filers, including a larger standard deduction and higher income thresholds for certain taxes and deductions.

Married filing separately

Because married couples are not required to file jointly, they can choose to file separately, where each spouse is taxed separately on the income he or she earned. However, this filing status typically results in a higher tax rate and the loss of certain deductions and credits. However, if one or both of the spouses have student loans with income-based repayment plans, filing separately could be beneficial if it results in lower student loan payments.

For help figuring out which filing status is better for married couples with student loans, we reached out to Mark Kantrowitz, publisher and Vice President of Strategy at Cappex.com. Kantrowitz knows quite a bit about student loans and taxes. He’s testified before Congress and federal and state agencies on several occasions, including testimony before the Senate Banking Committee that led to the passage of the Ensuring Continued Access to Student Loans Act of 2008. He’s also written 11 books, including four bestsellers about scholarships, the FAFSA, and student financial aid.

Two Advantages to Filing Taxes Jointly:

  • Most education benefits are available only if married taxpayers file a joint return. This can affect the American opportunity tax credit, the lifetime learning credit, the tuition and fees deduction (which Congress let expire as of January 1, 2017, but is still available for 2016 returns), and the student loan interest deduction.
  • Couples taking the maximum student loan interest deduction of $2,500 in a 25% tax bracket would save $625 in taxes. But this “above the line” deduction also reduces Adjusted Gross Income (AGI), which could yield additional tax benefits (e.g., greater benefits for deductions that are phased out based on AGI, lower thresholds for certain itemized deductions such as medical expenses, and miscellaneous itemized deductions).

However, there is a potential downside to filing jointly for couples with student loans.

Income-driven repayment plans use your income to determine your minimum monthly payment. Generally, your payment amount under an income-based repayment plan is a percentage of your discretionary income (the difference between your AGI and 150% of the poverty guideline amount for your state of residence and family size, divided by 12).

  • If you are a new borrower on or after July 1, 2014, payments are generally limited to 10% of your discretionary income but never more than the 10-year Standard Repayment Plan amount.
  • If you are not a new borrower on or after July 1, 2014, payments are generally limited to 15% of your discretionary income, but never more than the 10-year Standard Repayment Plan amount.

Because filing jointly will increase your discretionary income if your spouse is also earning money, your required student loan payment will typically increase as well. In some cases, the difference is negligible; in others, this can add up to a pretty significant cost difference.

“Calculating the trade-offs of income-driven repayment plans versus the student loan interest deduction and other benefits is challenging,” Kantrowitz says, “in part because the monthly payment under income-driven repayment depends on the borrower’s future income trajectory and inflation, not just the inclusion/exclusion of spousal income.”

Fortunately, some tools can help you run the numbers.

An example: Meet Joe and Sally

Here’s a simple scenario that shows how a change in filing status can save on taxes but cost more on student loans:

  • Joe and Sally are married with no children.
  • They live in Florida (no state income tax).
  • Joe is making $35,000 per year and has $15,000 of student loan debt with a 6.8% interest rate.
  • Sally is making $75,000 per year and has $60,000 of student loan debt with a 6.8% interest rate.

First, we can estimate Joe and Sally’s tax liability for filing jointly versus separately. TurboTax’s TaxCaster tool makes this pretty easy. Here’s what we get when run their numbers using 2016 tax rates:

  • Filing jointly, Joe and Sally would owe $13,249 in federal taxes.
  • Filing separately, they would owe $15,178.

So they would save just over $1,900 in federal taxes by filing jointly. But how would filing jointly affect their student loan payments?

We can use a student loan repayment estimator like the one provided by the office of Federal Student Aid to find out. Here’s what we get when we run the numbers and choose the Income-Based Repayment option, assuming they are new borrowers on or after July 1, 2014:

  • Filing jointly, Joe’s minimum required monthly student loan payment under a standard repayment plan would be $143, and Sally’s would be $571, for a total of $714 per month.
  • Filing separately, Joe’s minimum required monthly student loan payment would be $141, and Sally’s would be $474, for a total of $615 per month.

Over the course of a year, Joe and Sally would only save $1,188 on their student loan payments by filing separately. Even with the additional loan payments they would have to make, filing jointly would save them $712 more than filing separately.

What’s best for your situation?

Every situation is different. The simple example above comes out in favor of filing jointly, but you will need to run your own numbers to figure out what is right for you. Here are additional tips to help you figure it out:

  1. Know how much you owe. Make a list of all loan balances, interest rates, and the type of each student loan you have. You can find your federal student loans on the National Student Loan Data System. You can find information on your private student loans by looking at a recent statement.
  2. Estimate your student loan payment options. Using a student loan repayment estimator like the one mentioned above, determine your required payments when filing separately versus jointly.
  3. Calculate your tax liability. Use a tool like TurboTax’s TaxCaster or 1040.com’s Free Tax Calculator to calculate your federal and state tax liability when filing separately versus jointly.
  4. Be aware of long-term consequences. Filing separately might result in lower monthly payments today but more interest paid over time. If you make it to the 20- or 25-year forgiveness point, that could have tax implications down the line. Kantrowitz points out that “forgiveness is taxable under current law, causing a smaller tax debt to substitute for education debt. The main exception is borrowers who will qualify for public student loan forgiveness, which occurs after 10 years and is tax-free under current law.” Keep those long-term consequences in mind as you make a decision.
  5. Consider steps to lower your AGI. Your eligibility for income-driven student loan repayment plans depends on your AGI, which is essentially your total income minus certain deductions. You can reduce this number, and potentially lower both your tax bill and your required student loan payment, by doing things like contributing to a 401(k), IRA, or Health Savings Account.
  6. Keep the big picture in mind. These decisions are just one part of your overall financial situation. Keep your eyes on your big long-term goals and make your decision based on what helps you reach those goals fastest.

Other unique situations

There are a few unique situations that make deciding whether to file jointly or separately a little more complicated. Do any of these situations apply to you?

Divorce and legal separation

Sometimes, determining marital status to file tax returns isn’t cut and dried. What happens when you and your spouse are separated or going through a divorce at year end? In this case, your filing status depends on your marital status on the last day of the tax year.

You are considered married if you are separated but haven’t obtained a final decree of divorce or separate maintenance agreement by the last day of the tax year. In this case, you can choose to file married filing jointly or married filing separately.

You and your spouse are considered unmarried for the entire year if you obtained a final decree of divorce or are legally separated under a separate maintenance agreement by the last day of the tax year. You must follow your state tax law to determine if you are divorced or legally separated. In this case, your filing status would be single or head of household.

Pay as You Earn repayment plans

Pay as You Earn (PAYE) is a repayment plan with monthly payments that are limited to 10% of your discretionary income. To qualify and to continue to make income-based payments under this plan, you must have a partial financial hardship and have borrowed your first federal student loan after October 1, 2007. Kantrowitz says the PAYE plan bases repayment on the combined income of married couples, regardless of tax filing status.

Unpaid taxes, child support, or defaulted federal student loans

If you or your spouse have unpaid back taxes, child support, or defaulted federal student loans, joint income tax refunds may be diverted to pay for those items through the Treasury Offset Program. “Spouses can appeal to retain their share of the federal income tax refund,” Kantrowitz says, “but it is simpler if they file separate returns.”

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Tax

What to Do When You Owe Taxes to the IRS

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Owing a debt you can’t pay is a situation nobody wants to find themselves in, and it can be especially stressful when that debt is owed to the IRS. Many people fear the IRS and not without reason.

The IRS has collection powers that many creditors don’t have, including garnishing wages, seizing bank accounts, and even putting liens on property. Yet many people occasionally face a situation where they have a tax debt they just can’t pay. There are many options for dealing with tax debt, but ignoring it and hoping it goes away is not one of them. If you find yourself in this unfortunate situation, check out these tips for facing tax debts.

Filing for a filing extension will not give you more time to pay back the debt

Some people mistakenly believe that if they extend their tax return, they’ll have additional time to pay the amount due with their return. But an extension is just an extension of time to file, not to pay. You are still obligated to calculate the amount you’ll owe and pay that by April 15, even if you’re not yet ready to file.

Pay as much of the debt as possible by the filing deadline

When you file an extension but don’t pay 90% of the tax you owe for that year, the IRS will charge a failure-to-pay penalty. The penalty is generally 0.5% per month on the balance of your unpaid balance, and it starts accruing the day after taxes are due. It can grow to as much as 25% of your unpaid taxes.

In addition, interest will accrue on any unpaid tax from the due date of the return until you pay your balance in full. The interest rate is determined quarterly and is the federal short-term rate plus 3%.

If you can’t pay the amount you owe, filing your return without making a payment won’t avoid penalties and interest, but it’s important to know that filing an extension won’t help you avoid them either. Just file on time and pay as much as you can to reduce penalty and interest charges.

Now that you’ve filed your return and know how much tax you owe, it’s time to consider your options for paying the balance due.

How to pay your tax debt

By credit card

If you don’t have the money to pay the amount due immediately, the IRS does accept credit cards, but be wary of paying your tax debt with plastic. Although the IRS doesn’t charge a fee to pay by credit card, the company that processes your payment will charge a fee ranging from 1.87% to 2.00% of the payment amount. Plus, you’ll need to consider the interest your credit card company will charge until you pay off the balance.

The IRS will charge a far lower interest rate than your credit card, which means you can pay off the debt much quicker.

Enroll in an IRS repayment plan

Paying a tax debt via credit card may not be an option if the amount due exceeds your credit limit, or it may not be the best choice if your credit card has a high interest rate. In that case, you may be able to work out a payment arrangement with the IRS. Just be aware that your account will continue to accrue penalties and interest until the balance is paid in full.

Here are three types of IRS repayment plans:

Short-term extension to pay

If the amount you owe is relatively small and you believe you can pay it off within 120 days, call the IRS and ask for a short-term extension of time to pay. This is not a formal payment plan. The IRS will just make a note on your account that you’ve been granted additional time to pay the full amount. During this period, they will not take any collection action against you.

Installment agreement

If you aren’t able to pay your debt in full within 120 days, Scott Taylor, a CPA with Piercy Bowler Taylor & Kern in Las Vegas, Nev., recommends that you contact the IRS to arrange an installment agreement. An installment agreement is basically a monthly payment plan. You can apply online for an installment agreement if you owe $50,000 or less in combined tax, penalties, and interest. For balances over that amount, you will need to complete Form 9465 and Form 433-F and send them in by mail.

With an installment agreement, you decide how much money you will pay each month and on what date you’ll make the payment. As long as your debt will be paid off within three years and you owe less than $10,000, the IRS has to accept your payment plan.

Fees

Keep in mind that the IRS also charges user fees for installment agreements. “Unfortunately for taxpayers, the fees have gone up as of January 2017,” Taylor says. The cost to set up an installment agreement is $225. If you apply online and choose to have the monthly payments directly debited from a bank account, the fee drops to $31.

If your ability to pay the agreed upon amount changes later on, you’ll need to call the IRS immediately. When you miss a payment, your agreement goes into default and the IRS can start taking collection action. For example, if your agreement calls for a $300 payment and you lose your job and aren’t able to make the payment, call the IRS before you miss a payment. They may be able to reduce your monthly payment amount to reflect your current financial situation.

Partial payment installment agreement

What if you owe so much that you can’t pay it off in a reasonable period of time? In that case, you may be eligible for a partial payment installment agreement. Like a regular installment agreement, you will make regular, agreed upon payments for a set period of time. However, the payments will not pay off the entire debt. After the agreement period ends, the remaining debt will be forgiven.

As you can imagine, the IRS doesn’t take debt forgiveness lightly, so applying for a partial payment installment agreement is more complicated than applying for a regular installment agreement. Instead of letting you decide how much you can afford to pay each month, the IRS will calculate your monthly payment by taking into account your outstanding balance, the remaining statute of limitations for collecting the debt, and the reasonable potential of collection.

To request a partial payment installment agreement, it’s best to consult a tax professional with experience handling tax debts. Before the IRS approves a partial payment installment agreement, you will need to have filed all of your tax returns and be current on your income tax withholding or estimated payments.

How to settle your tax debt (offer in compromise)

You’ve probably heard the television commercials promising to help you “settle your tax debt for pennies on the dollar.” These ads refer to an offer in compromise (OIC), and they’re not as easy to get as those ads would have you believe.

With an OIC, you agree to a lump-sum or short-term payment plan to pay off a portion of your debt in exchange for the IRS forgiving the remainder of the debt.

To qualify, you must prove that you are unable to pay off the entire debt through an installment agreement or other means. It can be difficult to meet the income and asset guidelines to qualify for an OIC, so it’s best suited for taxpayers with low income and very few assets.

You can check to see if you are eligible for an OIC by using the IRS’s pre-qualifier tool. To apply, you’ll need to complete Form 656 and Form 433-A and submit them along with an application fee of $186. You’ll also be asked to provide documentation to support the financial information provided in the forms.

Again, it’s a good idea to get help from a tax professional with experience working with OICs to help you complete the forms and walk you through the complex process. Be wary of tax resolution firms making promises that sound too good to be true. Check with the Better Business Bureau and the state attorney general’s office for complaints before you pay a retainer.

Tax debt discharge

There is a 10-year statute of limitations on tax debt collection, so if you are having serious financial issues and can’t pay at all, letting that statute run out may be an option. To do this, you’ll need to get your tax debt in currently-not-collectible (CNC) status by demonstrating that you cannot pay both reasonable living expenses and your tax debt.

To request CNC status, the IRS will ask you to provide financial information on Form 433-A or Form 433-F and provide documentation to support amounts listed on the statement. If you have any assets that the IRS believes could be sold to pay your debt, they may not grant CNC status.

While your account is in CNC status, the IRS will not pursue collection, but if you are owed any tax refunds on returns filed while your account is in CNC status, the IRS may keep your refunds and apply them to your debt. They may also file a Notice of Federal Tax Lien, which can affect your credit score and your ability to sell your property.

The IRS will review your income annually to see if your situation has improved. If you maintain CNC status until the 10-year statute of limitations runs out, you may no longer be required to make payments, regardless of whether your financial situation improves later on.

What if you don’t agree with the amount due?

If you owe a lot more than you expected, take a moment to review your completed return carefully to look for errors. Make sure you didn’t accidentally enter the same income twice or forget an important deduction, and make sure you answered all of the questions correctly. One missed question or checkbox can cause you to miss out on valuable tax benefits. Also, compare this year’s return to last year. If your tax bill went up drastically even though your situation hasn’t really changed, find out why.

Occasionally, taxpayers receive notices from the IRS indicating an amount due that they don’t agree with. Don’t feel like you have to pay an amount you don’t believe you owe just because it comes on IRS letterhead. Taylor says each notice will include a section detailing how to respond.

“The IRS may have made an error in matching up 1099s or W-2s, and the amount owed needs to be adjusted,” he says, and he recommends that you send a letter via certified mail in response, with a full explanation. “A CPA can help you with this letter, but if you follow the guidelines provided by the IRS, you should be able to respond appropriately and have the fees resolved or adjusted.”

IRS collection enforcement

If your taxes are not paid on time and you do not communicate with the IRS, they can issue a Notice of Levy. An IRS levy permits the legal seizure of your property. They may garnish your wages or seize your bank account, vehicles, real estate, or other personal property to satisfy the debt.

Taylor says IRS notices will only come via U.S. mail, so be sure you check your mail and read all IRS notices. “It seems like a simple thing,” Taylor says, “but with many financial and personal transactions occurring online, many people ignore their mailbox for long periods of time.”

Whatever your situation, Taylor says it’s important to remain in contact with the IRS to show your intent is to pay your debt. “Don’t ever ignore IRS notices,” Taylor says. “The IRS is willing to coordinate payment plans, and the consequences of ignoring them are always difficult to adjust.”

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Featured, News

Tax Tips for Recent College Graduates

Editorial Disclaimer: The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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Tax Tips for Recent College Graduates

When life changes, so do your taxes, and graduating from college brings several life changes that can affect your tax return. You may go from being claimed as a dependent by your parents to filing on your own for the first time. You may move out of state, collect a paycheck for the first time, and start paying off student loans. All of these events present opportunities to save — and costly pitfalls to avoid. To help you keep more of what you earn in this next phase of life, check out these tax tips for recent college graduates.

Figure out if your parents can still claim you as a dependent

If you just graduated, you may still be eligible to be claimed as a dependent on your parents’ tax return. Dependency rules are complex, but essentially, for your parents to claim you as a dependent:

  • you must be under age 24 at the end of the year,
  • you must be a full-time student (enrolled for the number of credit hours the school considers full time) for at least five months of the year,
  • you must have lived with your parents for more than half the year (you are deemed to live with your parents while you are temporarily living away from home for education), and
  • your parent must have provided more than half of your financial support for the year.

If you meet all of these tests, your parents can still claim you as a dependent and take advantage of the dependency exemptions and education credits.

Even if your parents claim you as a dependent, you may still be required to file your own return if you had more than $2,600 of unearned income (interest, dividends, and capital gains) or more than $7,850 of earned income (wages or self-employment income).

Get reimbursed for moving expenses if you moved in order to take a new job

If you moved for a new job after graduation, you might be able to deduct any unreimbursed moving expenses, as long as the new job is at least 50 miles away from your old home. Those expenses include costs to pack and ship your belongings and lodging expenses along the way, but not meals. You can also take a deduction for 17 cents per mile driven for 2017 (down from 19 cents per mile in 2016).

If you moved out of state, you might have to file two state returns if you had taxable income in both states. Many students have a part-time job while in school and take a full-time job in another state after graduation. Rules vary drastically by state. In some states, you will have to claim 100% of your income on your resident state return, then receive a credit for any taxes paid to another state. In this case, you may be better off working with a professional who can help guide you through filing in both states.

Make sure you’re withholding the right amount from your paycheck

When you start your new job, the human resources department will ask you to complete a Form W-4 to indicate how much of your paycheck you’d like your employer to take out for taxes. Working through the questions on the form is simple enough, but it doesn’t take into account how much of the year you’ll be working.

Most new graduates end up having too much federal tax withheld in their first year, effectively giving the government an interest-free loan, says Bradley Greenberg, a CPA and partner at Kessler Orlean Silver & Co. in Deerfield, Ill.

That’s because graduates rarely start new jobs right at the start of a new year. You may graduate in May and start working in June, or graduate in December but not find a job until February. Yet you are taxed as if you have been earning that pay for the entire year.

“The withholding tables are designed with the assumption that one makes the same amount of money for each pay period of the year, regardless of how many pay periods were worked,” Greenberg says. “For example, a June graduate starting a job on July 1 for $50,000 will have the same taxes withheld per pay period as a colleague with the same salary, marital status, and number of exemptions, but who worked the entire year.”

Greenberg recommends two courses of action for new graduates:

  1. Set up your withholding in your first year of employment so less tax is withheld. Then make sure you adjust it on the following January 1, so you don’t have too little tax withheld in your first full year of employment, or
  2. View this as a savings plan and file your taxes as early as possible next year to get your refund from the IRS.

Take advantage of student tax credits

If your parents can no longer claim you as a dependent, you may be eligible to claim valuable tax credits for any tuition you paid during the year. There are two tax credits for higher education costs: the Lifetime Learning Credit and the American Opportunity Credit.

For 2016, there is also the tuition and fees deduction (Congress failed to renew this deduction, which expired on December 31, 2016, so it is not available for 2017). The rules and income limits for each credit and the deduction vary, but the IRS offers an interactive tool on their website to help you determine which tax break applies to you.

If you used student loans to pay for your education, you can take a deduction for up to $2,500 of interest paid on a qualified student loan. If your parents made loan payments on your behalf, you are in luck. Typically, you can only deduct interest if you actually paid the debt, but when parents pay back student loans, the IRS treats it as if the money was given to the child, who then repaid the debt.

Don’t ignore your 401(k) or health savings account at work

New college graduates may be financially strapped and hesitant to divert part of their paycheck into a retirement plan or health savings account, but opting out means missing out on substantial tax-saving and wealth-building opportunities.

If your employer offers a matching 401(k) contribution, as soon as you’re eligible you should contribute at least enough to get the employer match. Otherwise, you’re missing out on free money. If you select a traditional 401(k), you can save on next year’s taxes. That’s because any contributions you make will be tax free, and they will reduce the amount of your income subject to federal income tax as well as Social Security and Medicare (FICA) taxes.

For better or for worse, many employers now offer high-deductible health insurance plans. These plans often come with health savings accounts (HSAs). Any money you set aside in an HSA can be used for any qualifying medical expense, from co-pays to prescriptions. The best part is that money you put into your HSA is not taxed, so you can potentially save a lot by using your HSA for medical expenses rather than paying out of pocket.

HSA funds stay in the account until you use them and are portable, meaning you can take it with you even if you leave your job. If you have big medical bills down the road, the funds can come in handy. If not, think of them as another tax-advantaged way to save for retirement.

Bring in a professional if you think you need help

If this is your first time filing on your own, you may be wondering whether you should do it yourself or pay someone to prepare your return for you. If you have a simple return with just a Form W-2 and perhaps some interest income, you could save money by buying some tax software and doing it yourself. MagnifyMoney’s guide to the best tax software is a great place to start.

But if you have dependents, investments, or a small business, you may be better off going to a reputable accountant.

Doing your taxes is never fun, but for recent college graduates, they may not be as big a headache as you might have heard. Keep in mind that tax laws often change, and everyone’s situation is a little different. But taking the time to know which tax breaks apply to you can make your post-college life significantly easier.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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9 Essential Tax Tips for Entrepreneurs

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9 Essential Tax Tips for Entrepreneurs

For many entrepreneurs, there is no topic more fraught than taxes. In fact, a 2015 survey of small business owners found that 40% say dealing with bookkeeping and taxes is the worst part of owning a small business and that they spend 80+ hours a year dealing with taxes and working with their accountants. Taxes can be time-consuming, confusing, and a drain on your finances if you don’t prepare well. So whether you choose to do your taxes on your own or hire a professional, this guide can provide some sound advice and hopefully make tax time a little less taxing.

 

#1 Select the Right Entity for Your Business

 

One of the first decisions you’ll make when setting up your business is whether to function as a sole proprietor, partnership, LLC, or corporation. In her recent blog post, Wendy Connick, an IRS enrolled agent and owner of Connick Financial Solutions, says “the type of business entity you choose will have a huge effect both on how you pay taxes and how much tax you pay. It’s wise to consider the pros and cons of each business structure before making a final decision.”

Sole proprietorship

A sole proprietorship is the simplest way to form a business, as it is not a legal entity. The business owner just needs to register the business name with the state and secure the proper local business licenses. The downside is that the sole proprietor is personally liable for the business’s debts.

Partnership

A partnership is similar to a sole proprietorship, but two or more people share ownership. Both partners contribute their money, labor, or skill to the business and share in its profits and losses.

Limited liability company (LLC)

An LLC provides more protection from liability than a sole proprietor or partnership but with the efficiency and flexibility of a partnership.

Corporation

A corporation is more complicated and usually recommended for larger companies with multiple employees. It is a legal entity owned by shareholders, so the corporation itself, not its shareholders, is legally liable for business debts.

Unlike other business entities, corporations pay income tax on their profits, so they are subject to “double taxation,” first on company profits and again on shareholder dividends.

To avoid double taxation, corporations can file an election with the IRS to be treated as an S Corporation. S Corporation income and losses “pass through” to the shareholder’s personal income tax return instead of being taxed at the corporate level.

Some small businesses and freelancers may save on self-employment taxes by registering as an S Corporation and paying themselves a salary. Sole proprietors, partners, and LLC members pay self-employment tax on their entire business net income, but S Corp shareholders only pay self-employment taxes on their wages. They can receive additional income from the corporation as a distribution, which is taxed at a lower rate.

Connick says “many small business owners start out as sole proprietors and adopt a different structure once the business gets big enough to make it worthwhile (which would typically be when the business is making over $50,000 a year).”

 

#2 Get an Employer Identification Number

 

All businesses, even sole proprietors should get an Employer Identification Number (EIN). Technically, sole proprietors can use their Social Security number (SSN) as the business’s identification number, but that means providing an SSN to any clients or vendors who need to issue a 1099, a move that can leave you more exposed to identity theft.

Applying for an EIN from the IRS is free and can usually be done in a matter of minutes using the IRS’s online form.

#3 Make Sure Your Business Isn’t Just a Hobby

 

You know you’re in business to make money, but would the IRS agree? If your company is operating at a loss, the IRS could reclassify your business as a hobby, resulting in some serious tax consequences.

A business is allowed to offset taxable income with business expenses, but hobby expenses cannot be netted against hobby income. Instead, they are deducted as miscellaneous itemized deductions on Schedule A and limited to the amount of hobby income reported on Schedule C. This means a hobby business can never result in a net loss, and you may be prevented from deducting hobby expenses entirely if you don’t itemize deductions.

If you’ve been making money in your business for a while and just have one bad year, you don’t have to worry about the IRS reclassifying your business as a hobby. If you’ve been losing money for a while and especially if your business involves some element of personal pleasure or recreation (such as horse racing, filmmaking, or restoring old cars), you’ll want to make sure you’re treating your business like a business in case the IRS challenges your losses.

The IRS takes several factors into consideration:

  • Does the amount of time you put into the business suggest an intention of making a profit? Side projects are more likely to face scrutiny because you’re spending the majority of your time at another full-time job.
  • Do you depend on the income you receive from the business?
  • Were any losses beyond your control or occur in the startup phase? Losses due to poor management and overspending are less likely to hold up under examination.
  • Have you changed operation methods to improve profitability? Many business experience setbacks. If you learn from mistakes and try to correct your course, the IRS is more likely to agree that you have the intention of running a profitable business.
  • Do you have the knowledge and experience necessary to be successful in your field?

If you are concerned about an IRS challenge of your losses, there are a few steps you can take to treat your activity as a business:

  • Keep thorough business books and records.
  • Maintain separate business checking and credit accounts.
  • Obtain the proper business licenses, insurance, and certifications.
  • Develop and maintain a written business plan.
  • Document the hours spent working on your business, especially if it is a side project.

 

#4 Track Income and Expenses Carefully

 

Maintaining separate business checking and credit card accounts is not only a good way to demonstrate that your business is not a hobby, but it’s also an excellent way to simplify tracking business income and expenses.

Benjamin Sullivan, an IRS enrolled agent and a certified financial planner with Palisades Hudson Financial Group LLC in its Austin, Texas, office, says “small business owners can get a tax benefit from almost anything that is an ordinary and necessary business expense. Travel, meals, advertising, and insurance costs are just some of the popular deductions.”

Use small business bookkeeping software

Small business accounting software like FreshBooks, Xero, or QuickBooks Online can help you easily and quickly track your business revenues and expenses. They can usually be set up to import transactions from your business checking account automatically and let you snap pictures of receipts with your phone.

Whether you choose to use a software program or just a spreadsheet, establish a system for organizing records and receipts right from the beginning. “Little expenses can add up quite a bit over the course of a year,” Connick says, “but you can’t deduct them if you don’t know what they are.”

Special rules for travel, meals, and entertainment

It is especially crucial to maintain good records for business travel, meals, and entertainment expenses. The IRS allows taxpayers to deduct 100% of their business-related travel and 50% of the cost of business meals and entertainment expenses, whether you are taking a client out for a meal or traveling out of town. Because these categories are prone to abuse, the IRS requires documentation to substantiate that these expenses have a legitimate business purpose.

For meals and entertainment, in addition to a receipt that shows the amount, time, and place, taxpayers should also make a note of the individuals being entertained and the business purpose. Meeting this requirement can be as simple as jotting down a note on your receipt or in your calendar regarding who you dined with and the business matters discussed.

For travel expenses, hotel receipts must include a breakdown of the charges for lodging, meals, telephone, and other incidentals. Your hotel should be able to provide an itemized receipt at checkout.

Save cash instead of taxes

One trap that small business owners often fall into is spending money to save on taxes. At year end, many entrepreneurs look at business profits and think they need to spend their cash to avoid a big tax bill. Don’t spend a dollar to save forty cents in tax. If you truly need a new computer, extra supplies, or a new vehicle, buy it. Don’t spend money just to avoid a tax bill. Remember, taxes are a cost of doing business. If you’re paying taxes, you’re making money.

#5 Set Aside Money for Taxes

 

When you set up a separate business checking account, it’s also a good idea to set up a separate savings account to help you organize funds and set aside money for taxes.

Our tax system is a “pay as you go” system. When you receive a paycheck from an employer, money is regularly withheld on your behalf. When you are self-employed, making estimated tax payments is your responsibility. If you don’t pay in enough during the year to cover your income tax and self-employment tax, you may have to pay an underpayment penalty.

Estimated tax payments are due on the 15th day of April, June, September, and the following January. You have a few options for calculating what you owe each quarter:

Use Form 1040ES

This form includes a worksheet to help you estimate how much you owe for the current year. (Corporations use Form 1120-W to calculate estimated taxes.)

Look at last year’s return

If you’ve been in business for a while and there are no significant changes this year, you can aim to pay 100% of last year’s tax as a safe-harbor estimate (110% if your adjusted gross income for the prior year was more than $150,000).

Make a quarterly estimate

If your income fluctuates, you may prefer to make a quarterly calculation. Calculating estimated payments is complex. It depends on your tax bracket, deductions, credits, etc. In this case, it’s best to work with a tax professional who can consider all of the factors and recent changes in the tax law.

Sullivan says, “Tax planning isn’t a one-time exercise that should be done at the end of the year or at tax time. Instead, tax planning is an ongoing process of structuring your affairs in a tax-efficient manner.”

#6 Don’t Forget to Track Your Mileage

 

When you drive your personal vehicle for business, you have two options for deducting business automobile expenses: the standard mileage rate or actual expenses.

The IRS releases the standard mileage rate annually. The rate is $0.54 per mile for 2016. It goes down to $0.535 cents per mile for 2017. You simply multiply the standard mileage rate by the number of miles you drove for business during the year.

To use the actual expense method, total up all of the costs of operating your vehicle for the year, including insurance, repairs, oil, and gas, and multiply them by the percentage of business use. For example, if you drove 10,000 miles during the year and 5,000 of those miles were for business, your percentage of business use would be 50%. If it cost $7,000 to own and operate your vehicle, your deduction using the actual expense method would be $3,500 ($7,000 x 50%).

You can use whichever method gives you the largest deduction. However, if you want to use the standard mileage rate, you must choose it in the first year the car is used for business. In subsequent years, you can choose either method.

Whichever method you choose, you must track your business miles. You can do that with a paper log kept in your glove compartment or with an app such as MileIQ or TrackMyDrive. “Note that ‘business purpose’ is a pretty broad category,” Connick says. “If you drive to the supermarket and pick up some pens for your home office while buying groceries, the trip counts as business mileage.”

 

#7 Consider the Home Office Deduction

 

Some business owners avoid claiming the home office deduction, believing it to be an audit trigger. That may have been true in the past, but today’s technology has made home offices much more common. Connick suggests entrepreneurs shouldn’t fear the home office deduction if they meet the requirements. “It’s no longer audit bait,” she says, “especially if you use the safe harbor method to calculate your deduction.”

To take advantage of the home office deduction, you must use the area exclusively and regularly, either as your principal place of business or as a setting to meet with clients. The home office deduction is based on the percentage of your home used for the business. You can choose either the traditional method or the simplified method for deducting expenses.

Under the traditional method, you’ll calculate the percentage of your home that is used for business by dividing the square footage of your office by the square footage of your entire home. For example, if your home is 1,500 square feet and your office occupies 150 square feet, the business percentage is 10%. Then, you can deduct 10% of all of the expenses of owning and maintaining your home, including mortgage interest, real estate taxes, utilities, association dues, insurance, repairs, etc.

Under the simplified method, you’ll take a deduction of $5 per square foot, with a maximum of 300 square feet. So if your home office measures 150 square feet, the home office deduction would be $750 (150 x $5).

 

#8 Save for Retirement

 

For most self-employed people, the simplest option for retirement saving is an individual retirement account (IRA). Anyone can contribute to a traditional IRA, but with an annual contribution limit of just $5,500 ($6,500 if you are age 50 or older), you may want a retirement savings option that allows you to save more.

Connick says her number one tip for entrepreneurs is to open a SEP-IRA. “These retirement accounts are cheap to open and maintain,” she says. They also “have a high contribution limit, and contributions are fully tax deductible.” SEP-IRAs allow entrepreneurs to contribute up to 25% of their net earnings from self-employment, up to a maximum of $53,000 for 2016.

The deadline to contribute to a SEP-IRA is the due date of your return, including extensions. So 2016 contributions can be made until April 18, 2017, or October 15, 2017, if an extension is filed.

 

#9 Get Help from a Professional

 

Connick recommends that entrepreneurs hire a professional to do their taxes. “If you pick someone who knows their stuff,” she says, “you will likely save more than enough off your tax bill to pay for their fees. For that matter, tax preparation fees are deductible!”

When choosing a tax professional, look for someone with experience working with self-employed taxpayers. The IRS maintains an online directory of return preparers who have additional credentials, such as EAs, attorneys, and CPAs. Search the directory to find a professional near you with the credentials or qualifications you prefer.

If there is one thing all entrepreneurs can agree on, it’s that everybody dreads tax season. Having a basic understanding of tax law, maintaining organized records throughout the year, and working with a professional can help you make the most of this least wonderful time of the year.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Can a Balance Transfer Hurt Your Credit Score?

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Can a Balance Transfer Hurt Your Credit Score?

When you are carrying a balance on a high-interest credit card, receiving a 0% balance transfer offer can be enticing. After all, shifting the balance from a high-interest credit card to a no-interest card means saving money on interest and paying down the balance faster.

But how will the balance transfer impact your credit score?

First, you should understand three crucial elements that go into determining your credit score: inquiries, credit utilization, and length of credit history.

  • Inquiries – How many new accounts have you opened lately? Whenever you apply for new debt, the lender performs a “hard inquiry” to determine whether they will approve your application. According to FICO, hard inquiries account for about 10% of your credit score.
  • Credit utilization ratio – How much do you owe? Your credit utilization ratio is calculated based on your total outstanding balances compared to your total credit limit. It is calculated both per card and across all of your credit accounts and makes up about 30% of your credit score.
  • Length of credit history – How long have you been using credit? This factor looks at the age of your oldest account as well as the average length of all of your credit accounts. The longer your history, the higher your score. According to FICO, the length of your credit history accounts for about 15% of your credit score.

How balance transfers can hurt your credit score

Balance transfer applications count as a hard credit inquiry

When you open a new account for a balance transfer, the lender will perform a hard inquiry. One hard inquiry is unlikely to have a large impact on your credit score. If you have excellent credit and haven’t applied for a card in the last six months, one hard inquiry may not impact your score at all. Inquiries could have as much as a ten-point impact, but that would be very rare. The typical impact of one hard inquiry is about five points. However, if you apply for several cards at once, the applications could have a big impact.

Balance transfers lower the average length of your credit history

Opening a new credit account will lower the average age of your credit accounts, which can negatively impact your credit score in the short term.

For example, if you have one 5-year-old credit card, one 3-year-old credit card, and one 10-year-old credit card, the average age of your cards is 6 years.

When you open a new credit card for a balance transfer, you now add a less-than-one-year-old account to your balance. At the most, your average credit age will drop down to 4.75 years.

How balance transfers can improve your credit score

All in all, the benefits of balance transfers can far outweigh the negatives.

You will likely lower your utilization rate

Opening new credit accounts decreases your overall credit utilization ratio, which positively affects your credit score over time. For example, if you have one credit card with a $5,000 limit and a $2,500 balance, your credit utilization ratio is 50%. When you open a second account with a $5,000 limit and transfer the $2,500 balance to the new card while leaving the old account open, your total available credit is $10,000 ($5,000 + $5,000), and your outstanding balance is still just $2,500. You’ve reduced your credit utilization rate to 25%.

What happens if the new account’s limit is just $2,500 and you transfer the full $2,500 balance? You’ve still reduced your overall credit utilization ratio. Now you’re using 33% of your available credit ($2,500 / $7,500). However, the negative is that there are still some points taken away if you max out one card. You didn’t have any maxed out cards before, and now you do. Credit scores are very sensitive to people who max out their credit cards as they’re seen as high risk. Maxing out a new card could reduce your credit score by about 30 points in the short term.

You will be paying off debt faster, improving your score dramatically

Where balance transfers get exciting is that more of your money is going to paying off the balance of your debt as opposed to interest. Ultimately, the best credit score comes from carrying as little debt as possible.

Using our previous example of the $2,500 balance on one card, assume that card had a 21% interest rate and you could afford to pay $220 per month toward paying it off. According to MagnifyMoney’s balance transfer calculator, if you did not take advantage of a balance transfer, the card would be paid off in 13 months, and you would pay $309 in interest. If you transferred that balance, even with a 3% balance transfer fee ($75), you could pay off that balance one month sooner and save $234.

In the end, your goal should be to pay off your debt as quickly as possible. Over the course of a year, as long as you stick to your strategy, you can eliminate that debt in a year, and your score will go up a whole lot faster than it otherwise would.

When to avoid balance transfers

The short-term impact of a balance transfer on your credit score should only concern you if you are planning on applying for a mortgage in the next six to nine months. During this period, every point on your score counts. Just a 0.2% difference in your interest rate can cost a ton of money over the life of your mortgage. In that case, wait until after you get the mortgage to do the balance transfer.

The bottom line

People are so programmed to think about their score that they sometimes lose sight of what they want the high score for. A higher score saves you money and gets you out of debt faster. Don’t focus on short-term fluctuations of 10 to 20 points. Use your good credit score to save money. That’s what it’s there for.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Guide to Handling Your Financial Life After Divorce

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Guide to Handling Your Financial Life After Divorce

Divorce is often a time of financial upheaval. Dan Burges, a financial adviser and Certified Divorce Financial Analyst (CDFA) with Ameriprise in Southlake, Texas, says, “Everything is different. Even if you are in the same house and same job, it is different. Your bills aren’t cut in half, but your income might be. You may even be spending more for child support and alimony.” So while it may be tempting to go on a spending spree to celebrate your newfound freedom – or go into hibernation mode and ignore your money altogether – it’s more important than ever to get educated about handling your financial life after divorce.

Don’t make rash decisions

Many people who are still reeling emotionally from a divorce are prone to making rash decisions they later regret, such as buying or selling real estate, cashing in retirement assets, or changing jobs or even cities. Take time to process and get yourself together — financially and emotionally — before you make any large purchases or other big financial moves.

Avoid the temptation to indulge in “retail therapy” after a divorce, whether to dull the pain, prove to yourself that you can still maintain your same standard of living, or just replace the material objects in your life with ones that don’t remind you of married life. If you must spend money, at least try to avoid using credit cards. Otherwise, bad decisions will just make your problems worse.

Set up your finances for success

The first step to managing your finances after divorce is to create a budget. “It’s especially important to think beyond your monthly expenses, such as mortgage and electricity,” says Avani Ramnani, a Certified Financial Planner (CFP) and CDFA with Francis Financial in New York, N.Y. “Think about one-time expenses such as vacations, weekend trips, and emergencies. People tend to forget about them.” Ramnani says you should also remember expenses relating to your home. “If you own your own home, something is always breaking down or needing repair. You need to account for these,” she adds.

Burges agrees that budgeting is essential in your new circumstances, and he recommends looking at your cash flow daily. “You’ve got the app on your phone,” he says, “Don’t be scared to look at it.”

Budgeting can also help you avoid getting deep into credit card debt, a common problem when people are adjusting to a new standard of living after divorce. Burges says he sees too many people with debt piling up before they realize it.

In addition to budgeting, there are several steps you should take to get your finances in order after a divorce.

Get all assets in your own name

If you kept the family home after the divorce, you need to refinance the mortgage to have your ex-spouse’s name removed from the loan. Just as you did when you initially took out the mortgage, you will have to apply for a loan and go through the underwriting process. But this time, the lender will look only at your income and credit so you will have to be able to qualify on your own. If the refinance is approved, you can have your ex-spouse’s name taken off of the deed to the property by filing a quitclaim deed. An experienced attorney can help with this. If you cannot qualify to refinance the mortgage in your name alone, your best course of action may be to sell the home and move on.

Bank accounts that were owned jointly may need to be closed and the assets transferred to new accounts in your name only. Typically, your bank will not be able to just remove your ex-spouse’s name from the account, even if the divorce decree assigns the account to you.

Cancel joint expenses

Any credit cards issued in both names will have to be closed and accounts reopened in your name. Think about other costs that were shared jointly such as utilities, auto loans, and leases.

Even if the divorce decree specifies that your ex-spouse is responsible for a debt, if any joint debts still have your name on them, missed payments will continue to affect your credit score.

Before you close any joint credit card accounts, consider opening a few accounts in your name. Once you start closing credit cards, your credit score will take a hit. Opening a few cards in your own name before you close the old accounts will ensure you continue to have access to credit.

While you’re at it, change the passwords on all your account pages, especially if they were known to your ex-spouse or partner.

Rebuild your credit

If your credit accounts were jointly held with your ex-spouse, they might be closed as part of the divorce process, and you may need to start rebuilding your own credit.

Part of your credit score is based on the length of your credit history, so closing all of your existing accounts and opening new accounts will negatively impact your credit score.

You may have also racked up debt to pay attorney fees or other expenses related to separating and setting up a new household. Your budget can help you plan for paying credit card bills and other debt payments.

Get into the habit of checking your credit report at least annually by pulling a copy of your credit report from all three credit bureaus for free through AnnualCreditReport.com. Watch out for other services that promise a free copy of your credit report but require you to sign up for other services.

Once you get your credit report, review all information to make sure that there are no errors and that none of your ex’s accounts or information are on your credit report. If you do find any issues, contact the credit bureau to have the error corrected.

Prioritize paying off debt

If you come away from the divorce with a lot of debt, make it a priority to pay it off as soon as possible. If you are living on a tight budget, that may mean being more frugal or getting a second job to bring in extra money.

Save money

Make sure your budget includes setting aside money for the future. Ramnani recommends taking stock of all of the assets you have left after a divorce – retirement, non-retirement, and real estate – to figure out if they are enough to last for the long term. “If a woman is dependent on spousal maintenance, at some point that will stop,” she says.

That’s because spousal support payments are rarely permanent, unless the spouse receiving payments is elderly or has health problems. The courts typically award alimony on a temporary basis in order to allow a former spouse time to complete an education program or get back into the job market. “You may think you can just live off of savings after the maintenance payments stop, but is it really enough to sustain you long term? Those questions can be difficult to face,” Ramnani says.

If a woman receives spousal support from her ex, Ramnani recommends setting aside spousal support payments for long-term savings.

A financial adviser can help you model your financial situation based on income, savings, Social Security, and other assets to see whether you have enough to continue your way of life or whether you need to make other plans to support yourself.

Consider hiring new financial professionals

Married couples often share financial and tax advisers. Should you continue working with the same professionals after a divorce or hire your own to avoid conflicts of interest? Burges says that decision is very personal. “Consider how much you trust that person. If the financial adviser and your ex were college roommates, then you should find someone else,” he says. “You need to feel confident that whatever you say to your adviser isn’t being repeated to your ex-spouse.”

Ramnani agrees that people should make their own decisions about whether to stay with the same adviser or find a new one. “At the end of the divorce process,” she says, “take stock and think about what makes the most sense.”

In some cases, your ex-spouse may have handled all of the finances, and this is your first time managing them on your own. Make sure you have someone with experience to help you navigate your new reality. Ramnani and her firm specialize in working with women going through emotionally traumatic life events. She says many of the women that come to her felt like their adviser had lost track of them since their ex-husbands were more involved.

Burges also recommends working with a certified public accountant the first time you file your taxes after a divorce, even if you are used to doing your taxes yourself. “Your taxes may be super simple,” he says, “but a CPA will ask you questions about things you may not have thought of before.”

Change beneficiaries on all of your assets

Changing beneficiaries is another important step to managing your finances after divorce. Most likely, your ex-spouse was named as a beneficiary on life insurance policies, auto insurance, retirement plans, annuities, and bank and brokerage accounts.

Burges points out, “if you switch advisers, you’ll have to set up new beneficiaries, so that is one way to clean up.”

If you and your ex have minor children, talk to your attorney before you name a minor child as a beneficiary. You may need to set up a trust. Otherwise, your ex-spouse may get control over any assets left to your kids.

You should also talk to your attorney about updating health care directives, living wills, and powers of attorney, so your ex-spouse isn’t in control if you are incapacitated.

Handling joint expenses

Divorced couples with children often need to continue sharing certain costs, such as summer camps, college expenses, and field trips, long after the divorce is finalized. What is the best way to handle these ongoing conversations?

In these cases, it pays to plan ahead. Ramnani says most attorneys today consider those items when drawing up the divorce agreement, and a good financial adviser can help you make sure all of your bases are covered if you let them take a look at the agreement while it is still in proposal form.

Burges recommends getting the divorce decree to explain, in detail, what child support covers. “Some people see child support as strictly covering a roof over their head, food, and clothing,” he says. Consider who will be responsible for paying for medical care, school fees and supplies, child care, extracurricular activities, music or dance lessons, your child’s first car, and even entertainment and travel expenses. “Try to get your lawyer to define what the child support is for. It may be something you argue about during the divorce process, but it will be worth it in the end. Set yourself up for success,” Burges says.

Ramnani also recommends keeping very detailed records of any joint expenses in case of disagreements. In the end, though, she says, “that’s the reality of life. If you share children, you still have to deal with each other. Hopefully, it’s at least a cordial relationship so you can speak openly.”

Dealing with college financial aid

Applying for college and navigating financial aid can be a stressful time for divorced couples. No matter your financial situation, you have to complete a Free Application for Federal Student Aid (FAFSA) in order for you or your child to access assistance from federal, state, and college financial aid programs.

Your FAFSA is used to determine your family’s ability to contribute funds for college. In order to arrive at that calculation, the application requests household income.

A divorce decree may allow one parent to claim the child as a dependent, even if the child lives with the other parent 90% of the time. For FAFSA purposes, who the child lives with matters because that parent’s income will be used to calculate their financial aid need. If maximizing college aid is a priority, it might make sense for the child to reside with the parent with the lowest income. In that case, the lower-earning parent should claim the child as a dependent on their tax return in the year before the child applies to college.

Gray divorce presents unique challenges

“Gray divorce” is the term for the divorce trend of Americans age 50 and older, and a 2013 study by researchers at Bowling Green State University found that the divorce rate among couples age 50 or older doubled between 1990 and 2012. While divorce can be a blow to the finances of couples at any age, it can be especially damaging for older couples who are close to retirement.

Burges says many retirement plans are made based on the couple not getting divorced. “Pensions, 401(k)s, annuities. You’ve been putting a plan together, then your assets get cut in half but your expenses in retirement don’t. That can be a massive setback on your retirement plan. He says the knee-jerk reaction is that you won’t be able to retire when you thought you would. “And that’s often true unless you’re able to really step up your retirement savings. If you’re 10 years or less out, that’s hard to do.”

The bottom line

Handling your financial life after divorce starts with a realistic evaluation of your current situation. That can be difficult to face if you are still reeling emotionally from the split or find yourself with more expenses and less income than you are used to working with. If you find it too difficult to do on your own, consult with a CDFA who will take the time to figure out where you are, where you want to go, and how to get there.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Mortgage

Guide to Reverse Mortgages: Is the Income Worth the Risk?

Editorial Disclaimer: The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Advertiser Disclosure

old senior couple at home house on couch

If you own a home, chances are you’ve heard of a reverse mortgage. Despite increased attention and regulation, many homeowners still struggle to understand what reverse mortgages are and who should consider one. This guide will provide an in-depth understanding of exactly what a reverse mortgage is and the pros and cons of this complex financial product.

What is a reverse mortgage?

Most homeowners are familiar with a regular mortgage: You borrow money from a lender to purchase a home, then repay the loan in monthly installments over the course of several decades.

With a reverse mortgage, the lender pays you by taking some of your home’s equity and converting it into monthly payments to you. As long as you live, remain in your home, and continue to meet other obligations of the mortgage (discussed in more detail later), you do not have to pay the money back.

When you die, sell the home, or move out, you or your spouse or estate will have to repay the loan. If you signed the loan paperwork but your spouse didn’t, your spouse may be able to continue living in the home after you die, as long as they continue to pay property taxes, insurance, and maintenance costs. However, your spouse will cease to receive monthly payments from the reverse mortgage, since he or she wasn’t a part of the loan agreement. Once your spouse passes away or moves out of the home, your family or heirs may need to sell the home to repay the loan.

Example of how a reverse mortgage works

James and Mary, ages 73 and 72, are a retired couple who own their home outright. They want to stay in their home but need to supplement their monthly income from Social Security and James’s pension. They would also like to remodel their kitchen. James and Mary’s home is valued at $250,000, and they do not have a mortgage.

The total amount that James and Mary can borrow using a reverse mortgage is limited by the Federal Department of Housing and Urban Development (HUD) and is based on the age of the youngest spouse, current mortgage rates, and the value of the home.

Let’s run a hypothetical scenario through the National Reverse Mortgage Lenders Association’s reverse mortgage calculator.

Value of the home $250,000
Loan principal limit $150,000
Closing costs -$7,800
Net principal limit $142,200
Lump sum cash for kitchen remodel -$20,000
Remaining for monthly advance $122,200
Monthly advance $750

James and Mary have been mortgage-free for a year. The current value of their home is $250,000, and they are applying for a $150,000 reverse mortgage. After accounting for closing costs of approximately $7,800, the remaining available principal is $142,200. James and Mary would like to have $20,000 of that up front for the kitchen remodel, leaving $122,200 available for monthly installments. Based on this scenario, the amount James and Mary would receive monthly is approximately $750.

Reverse mortgage requirements

Businesswoman pushing button on touch screen

To qualify for a reverse mortgage, you must:

  • Be age 62 or older
  • Own your home outright or have a small mortgage (meaning the amount you owe on the mortgage is less than the amount you qualify for under the reverse mortgage program)
  • Use the home as your primary residence
  • Not be delinquent on any federal debt, such as back taxes, federally backed student loans, SBA loans, or HUD-insured loans.
  • Have the financial resources to continue to meet obligations such as property taxes, homeowners insurance, association dues, and repairs
  • Participate in an information session with a HUD-approved Home Equity Conversion Mortgages counselor

Meeting these basic requirements doesn’t necessarily mean a reverse mortgage is right for you.

3 questions to ask yourself when considering a reverse mortgage

  • Do you want or need to move? This question should help you understand whether or not your home will continue to meet your needs for the foreseeable future. If your home is physically difficult for you to navigate and maintain, you may be better off selling the home and downsizing to a home that is better suited to your retirement years. A reverse mortgage requires you to continue to reside in and maintain the home. If you are physically or financially unable to do that, you may have to sell the home to pay off the loan balance.
  • Can you afford to continue paying real estate taxes, homeowners insurance, association dues, and maintenance? While a reverse mortgage will boost your monthly income, consider whether that additional cash flow will be enough to continue covering real estate taxes, insurance, association dues, and home maintenance. Keeping up with these obligations is a requirement of a reverse mortgage. If you cannot afford to keep up with these expenses and your other bills, including health care, utilities, and other living expenses, a reverse mortgage may not make sense.
  • Are you planning on leaving your home to your children, grandchildren, or other heirs? When you pass, your heirs may have to sell the home to pay off the reverse mortgage. Other assets, such as investments or life insurance, may be available to pay off the loan balance. If your sole motivation for staying in the home is to pass it on to heirs, consider whether they’ll be able to hold on to it after you are gone.

Robin Faison is a licensed mortgage loan officer specializing in reverse mortgages with Open Mortgage in Scottsdale, Az. Faison also teaches a Reverse Mortgage for Purchase class accredited through the Arizona Department of Real Estate.

Faison says reverse mortgage borrowers typically fall on a spectrum, from those who are facing foreclosure and need a reverse mortgage to keep their homes, to those who are not in any financial difficulty and use a reverse mortgage line of credit strategically as a part of their overall retirement plan.

Reverse mortgage risks

A reverse mortgage is a financial product, and all financial products come with risks. Make sure you understand those risks before signing any paperwork. Those risks may include the following.

Fewer assets for heirs

Some homeowners dream of holding on to the family home and passing it down to their children or grandchildren. If this is part of your estate plan, consider whether your heirs will need to sell the home to pay off the reverse mortgage.

Even if you have life insurance proceeds or other assets that can be tapped to pay off the reverse mortgage after your death, those assets may be depleted, leaving less for your family members. Work with your financial adviser and a reputable reverse mortgage specialist to make sure that a reverse mortgage works with your overall estate plan.

Fees and other costs

Real estate investment. House and coins on table

Just like with a conventional mortgage, you will pay closing costs, mortgage insurance premiums, origination fees, and other costs to close on a reverse mortgage. According to the Consumer Financial Protection Bureau (CFPB), the fees and other costs of a reverse mortgage vary based “on the type of loan you choose, how much money you take out up front, and the lender you choose.”

Faison says lenders also receive a premium for servicing your loan (typically from Fannie Mae or Freddie Mac), which can be used to offset closing costs. However, regulations have made it more difficult for banks to offset costs on a fixed rate loan. Your lender will have more leeway for offsetting closing costs with that premium on an adjustable rate mortgage, but then the borrower bears the risk of rising interest rates.

Will owe more over time

As you receive money from the reverse mortgage, interest is added to the balance you owe each month. The amount you owe grows as interest on the loan balance adds up over time. Faison says many borrowers choose to make some payments on their reverse mortgage in order to keep the loan balance down.

Variable rates

Most reverse mortgages have variable rates. While these loans have more flexibility than fixed rate mortgages, your rate can rise quickly and dramatically.

HUD publishes statistics on all federally backed reverse mortgages each month. For October 2016 (the most recent month for which information is available at the time of this writing), interest rates on adjustable rate reverse mortgages range from 2.507% to 6.045%.

Interest is not tax deductible

Unlike a traditional mortgage, the interest you’ll pay on a reverse mortgage is not tax deductible until the loan is paid partially or in full.

Need to continue paying other obligations

You will still be responsible for paying property taxes, insurance, utilities, fuel, maintenance, and other standard costs of keeping up the home, just as you would with a conventional or no mortgage. If you cannot or do not continue to pay real estate taxes or insurance or to maintain the home, the lender may require repayment of the reverse mortgage.

May require “set-aside” amounts

Lenders are required to conduct a financial assessment to ensure borrowers have the financial capacity to continue paying obligations such as property taxes, homeowners insurance, and maintenance. If the lender determines that the borrower may not be able to keep up with such payments, they may require “set-aside” amounts to cover future obligations.

The set-aside amount is based on a formula that takes into account your current property taxes and homeowners insurance premiums, projected increases to taxes and insurance rates, monthly interest rates, and the life expectancy of the youngest borrower. While set-aside amounts help ensure borrowers can continue to meet loan obligations, those amounts will reduce your payment amounts.

Unscrupulous advice

Some unscrupulous advisers try to pressure borrowers into using proceeds from a reverse mortgage to purchase other financial investments. The Financial Industry Regulatory Authority (FINRA) warns consumers to be skeptical of such advice. If those other investments lose value, you or your heirs may not have the means to pay off the reverse mortgage balance and may have to sell the home.

Primary residence requirement

Faison says she also reminds all of her clients about the obligation to continue using the home as your primary residence. You only need to live in the home for six months and one day out of the year for the home to qualify as a primary residence.

Annually, the lender will mail an affidavit that the borrower needs to complete, sign, and send back to confirm they are still there. Make sure to respond to those notices. Otherwise, the lender may believe you are no longer living in the home and take steps to collect on the loan balance.

How to shop for a reverse mortgage

Reverse mortgages are not one-size-fits-all products. Here are a few things to keep in mind when selecting a reverse mortgage.

Types of reverse mortgages

  • Single-purpose reverse mortgages. These are offered by some state and federal agencies and nonprofit organizations. As the name implies, the loans can be used for only one purpose, such as home repairs or improvements or property taxes.
  • Proprietary reverse mortgages. These are private loans without federal backing. Owners of higher-valued homes may receive bigger advances from a proprietary reverse mortgage.
  • Home Equity Conversion Mortgages (HECMs). HECMs are federally insured and backed by HUD. Proceeds can be used for any purpose. An HECM may be more expensive than a traditional home loan, but they offer more flexibility. Borrowers can choose several payment options, including:
    • Single disbursement
    • Fixed monthly advances over a specified period of time
    • Fixed monthly advances as long as you live in your home
    • A line of credit
    • A combination line of credit and monthly payments

Other considerations for choosing a reverse mortgage

Faison recommends working with a local licensed loan officer who specializes in reverse mortgages or HECMs. “It’s fine to work with companies you hear about on TV,” Faison says, “but I often work with people who heard about reverse mortgages on the television but then decide they want to work with someone local.”

No matter who you work with, make sure you understand all costs involved. Loan expenses, including origination fees, interest rates, closing costs, and servicing fees, can vary among lenders. Make sure you fully understand the total cost of the loan.

How long do reverse mortgages take?

Clock time deadline

Depending on where you live and how busy appraisers are in your area, it could take two months or more just to get an appraisal on your home, which is only the first step in the process.

Faison also recommends asking your loan consultant how long the reverse mortgage process will take. If you are facing foreclosure or need money right away, a reverse mortgage may take more time than you have. Faison says some lenders may take 60 days or more, depending on the appraisal. “The appraisal industry has undergone a lot of change recently, and there are fewer appraisers available,” Faison says.

Alternatives to a reverse mortgage

A reverse mortgage isn’t right for everyone. Faison speaks with many people who ultimately are not good candidates. Credit issues may stand in the way of passing a financial assessment. In other cases, homes haven’t been maintained and are unable to pass the appraisal process. These problems can be resolved. However, if they are impossible to overcome, alternatives to a reverse mortgage include the following.

Refinance existing mortgage

If you have an existing home loan, you may be able to refinance your mortgage to reduce your monthly payments and free up some cash.

Take out a home equity loan or line of credit

If you own your home outright, you may be able to take out a home equity loan or line of credit. You will still be responsible for monthly payments, but the interest on the loan is usually tax deductible up to $100,000.

Sell your home and downsize or rent

If you are willing and able to move, selling your home to downsize or rent will free up the equity in your home, giving you extra cash to save, invest, or spend. You could also sell the home to your kids or another family member. Often, people who sell the home to a family member use a sale leaseback agreement where they rent back the home using proceeds from the sale.

REX agreement

A REX agreement is an alternative to a home equity line of credit. It allows you to access the equity in your home, giving you a cash payment of a percentage of your home’s market value (typically 12% to 17%) in exchange for 50% of the increase in your home’s value when it is sold. For example, if the home is worth $100,000 when the REX agreement is signed, the homeowner may receive a cash payment of $12,000 to $17,000. If the home increases in value by $50,000 over the next 10 years, when the home is sold, the company receives $25,000 (50% of the $50,000 increase).

Rent out part of your home

If you want to stay in your home but need some additional income, you may be able to rent out a part of your home to a roommate. Be sure to screen candidates carefully.

The bottom line

If you are considering a reverse mortgage of any kind, make sure you understand the pros and cons of this complex financial product before you sign. The television commercials may make it look easy, but a reverse mortgage is a serious financial commitment that comes at a cost and may impact potential heirs.

If you do not have the money to continue living in your current home at your current lifestyle, borrowing money against your home equity may not be the best option. Discuss your situation with a trusted adviser and a reputable, licensed loan officer with experience in reverse mortgages and HECMs. If you do decide that a reverse mortgage is right for you, review the different types of reverse mortgages and shop around for the best terms and rates. Do some research to find a counselor or company who will take the time to help you understand the costs and obligations before making any decisions.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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