Marketplace

Income-based student loans

Question: You recently reported on a student loan option that was being offered as part of the government stimulus package, which is based on a person's income. I have searched you website and have been unable to find the story. I was wondering if you could please let me know where to find this information. Thanks. Ethan, Minneapolis, MN

Answer: It's called an income-based repayment plan. It uses a formula that takes into account income, family size and your state. The payment requirements are on a sliding scale, but for most people their monthly student loan tab should run at 10% or less of their income.

The Education Department gives this example: Let's say you owe $25,000 at 6.8% interest. You're single, and earn an adjusted gross income of $30,000. Under the standard 10-year repayment your monthly bill is $288. But you qualify for the income-based repayment plan your monthly payment drops to $172 a month; married, the bill falls to $102; married with one kid, $32; and so on.

This plan makes it much easier to meet your monthly obligation. The price is that the overall cost of your student loan goes up if you don't eventually attack it more aggressively. After 25 years what remains of the loan is forgiven. The loans must be federal student loans.

A good source of information about all aspects of paying for college--including income-based repayment--is finaid.org. The federal government has upgraded its information on student loans at federalstudentaid.ed.gov.

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Gift stock to Mom

Question: What are the tax implications of giving a gift of appreciated stock to parents? I have some stock which has appreciated over the last couple of years and would like to gift some of it to my mother. Does her cost basis become zero when she sells it? Would it be better for me to sell it, pay the capital gains taxes, and have her rebuy it with the proceeds? Jim, Cincinnati, OH

Answer: When it comes to taxes there are always two phrases I have to write. The first is, "it all depends." The second is "check with a tax professional." I'm certainly not a CPA.

That said, gifting appreciated stock to your parents could be a savvy move depending on several moving parts.

Here's an example with several assumptions: You say you bought the stock several years ago and it appreciated in value. Let's assume you bought the stock for $10 a share and when you gift it the value is $20 a share. The total value of your gift is below the current $13,000 gift tax exclusion. Your Mom is in a lower tax bracket than you're in.

Okay, you gift her stock at $20 a share. She turns the stock into cash by selling it immediately at $20. Now, her cost basis for figuring out her tax liability is $10 a share--the price you bought it at. However, she also gets to take advantage of the low capital gains tax rate since you owned the stock for more than a year. Better yet, if she's in a low tax bracket her capital gains tax rate could be below yours. For instance, the long-term capital gains tax rate for folks in the 10% and 15% tax brackets is zero. That's right, 0%. The long-term capital gains rate for everyone else is 15%. (These rates only hold through 2010. They change in 2011.)

As you can see the devil is in the details. Change one assumption and the tax implications shift. Still, the idea is worth pursuing. It could be a very cost effective way to get money to your Mom. And that's always a nice thing to do.

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Cash in college savings

Question: Our oldest son is a junior in high school. We had been saving for college in a mutual fund. When the downturn hit last fall, we stopped adding to the mutual fund, and put our monthly contributions into a CD that can receive automatic monthly additions at 3.75%.

The mutual fund has recovered some ground since its low point. When should we start moving money out of the mutual fund and into something more stable? We could get a 2.5% CD at our credit union now. Thanks for your advice! Evelyn, MN

Answer: You really don't have much time before your son goes off to college. (I know this the hard way. I have a senior in high school and the time just flew by.) So, I would focus on taking advantage of market rallies to opportunistically lock in the value of your savings with FDIC insured CDs and the like (or their credit union equivalents).

You do have some time in a financial sense. It's six years between now and graduation from college. Still, I would lean on the conservative side with this money. You'll be writing tuition, room and board checks before you know it and you don't want to see your savings vaporize in another bear market.

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Taxes and short sale

Question: I'm trying to find out the tax implications of selling our house in a short sale. Basically, our house was on the market for 2years and after the real estate downturn, it appraised for 70,000 less that what we owed on our mortgage. We weren't in a position to keep the house and "ride it out" so we did a short sale and the bank accepted an offer of 70,000 less than we owed. I'm hoping you can tell me how this figures into our taxes. I heard that in the past, when a lender forgives a debt, it is considered income. But then more recently I heard that the government changed that tax policy for short sales. I just don't know how to find out more. Thanks for your help! Jen, Salisbury, CT

Answer: You should be okay on the tax front. Thanks to the Mortgage Relief Act of 2007 signed by President Bush you shouldn't owe taxes on the amount forgiven on a short sale of your primary home between 2007 and 2012. But the best advice I can give is for you to consult with a tax expert.

Here's the background. It used to be that the IRS would treat the amount forgiven by the bank in a short sale as income. You'd get a 1099 on the "gain." But in response to the housing crisis the tax treatment of a short sale was suspended until 2012. The IRS has a discussion of the tax treatment of debt relief here.

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Reward companies not Wall Street

Question: I will retire this year at age 65. My husband and I are both conservative financially. We own outright our farm and two rental properties. I moved all the assets in my 401K to a cash account two years ago, so I have not suffered loses there (a good thing since I work for AIG!). I realize I must move some money into equities to keep up with inflation over time, but I don't trust any financial advisor (I have some experience) and I certainly don't want to invest in a way that will pour money into the coffers of Wall Street analysts and traders. Here is my question: when one invests in stocks (funds or individual) on the NYSE or Nasdaq, does Wall Street automatically profit? I want to 'Invest in America,' but I don't want to reward unethical financiers. I bet there are a lot of small investors who feel the same way I do. Thank you for any words of advice. Melinda, Burns, TN

Answer: Many people agree with you. And I imagine you have some stories to tell about living through all the turmoil at AIG.

Wall Street profits in most cases when it comes to buying stocks. But there are ways to limit the amount that goes into the pockets of financiers.

Now, you already know this, but to reiterate: When you buy publically traded stocks the money usually doesn't go to the company. The investor who sells the stock gets the gain or the loss. Companies get investor money during an initial public offering (IPO) and with any subsequent additional sales of shares. However, it's easier for a company to get access to capital--such as borrowing--when investor show their enthusiasm for its business by bidding up its stock price.

With funds, one way to limit Wall Street's gain is to buy a major stock index, either through a mutual fund or an exchange traded fund. The annual fees on both types of fund are razor thin. You can take another step in this direction by purchasing socially responsible index funds. This kind of investment combines low fees along with putting your money into companies you like and managements you'd like to reward.

With an index fund you aren't paying for the services of a professional money manager or advisor. You're your own money manager.

With individual shares, I wonder if it would work for you to buy stock directly from a company? There are a number of large companies, typically major national and multinational corporations, that offer shareholders direct purchase plans--you can buy company stock without going through a broker.

You can learn more about companies offering this kind of plan by going to betterinvesting.org. It offers a long list of companies with direct purchase plans, starting with 3M and ending with Zion Bancorporation. (Betterinvesting is the website for the National Association of Investors Corporation, the umbrella organization for many investor clubs).

I do believe that there are many ethical financial firms in the country, from many credit unions to a number of mutual fund companies. I'd do business with financial companies with a strong track record of good service and low fees, along with a proven willingness by management to steer clear of fads that eventually harm customers.

One last point: Do you need to invest in stocks to stay ahead of inflation? Don't get me wrong. I am a big fan of equities. But would purchasing Treasury Inflation Protected Securities--a hedge against inflation--be a better bet for you? It's worth exploring.

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Foreclosure on death

Question: For a couple that has a good payment history... Is the death of a spouse enough cause for a bank to foreclose a mortgage? Andrew, Berkeley, CA

Answer: Absolutely not. No way. Nyet. The bank only cares about getting the mortgage payment on time. The only reason for a bank to put a home into foreclosure is if payments aren't being made (And in today's environment at least some people who haven't been able to keep up on the mortgage are able to get it modified so that they can stay in the home. ) As long as the mortgage check is cut every month the surviving spouse keeps the home. There will be some paperwork involved if the name of the surviving spouse wasn't on the mortgage. But foreclosure on death? No.

Of course, this is a purely money and cents answer; I'm not addressing the grief and sorrow of losing a spouse.

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Books on retirement

Question: There seems to be lots of books and articles about how to save your money for retirement, but not too much about creating a strategy for using your "nest egg" during retirement.... how to balance the needs for withdrawing cash, and investing to keep up with inflation, and managing longevity "risk" (out-living your "nest egg"). Any recommended reading........? Thanks, Steve, Tulsa, OK

Answer: Ah, a book question. I love them. A good place to begin is Henry Hebeler's Getting Started In A Financially Secure Retirement. The financial advice is conservative and thoughtful. Now, he covers a wide range of issues, from saving money as you age to deciding when to take Social Security. You can supplement what he writes about by visiting his website, analyzenow.com.

Jake Warner is the founder of Nolo.com, the self-help legal organization based in the Bay Area. He wrote a delightful book that touches on some of the issues you've raised, called Get a Life: You Don't Need a Million to Retire Well. He offers up a good foundation. You can then hone in on some of the specifics about managing a nest egg, figuring out how much to take out, and similar questions by reading his blog at retirehappyblog.com.

This next suggestion isn't a fun read. You won't curl up in front of a fireplace with a glass of wine and look at it. But the rules about putting money into a 401(k), IRA, and similar retirement savings plans are complicated. The regulations about getting the money out are equally (if not more so) Byzantine. It can cost you a lot of money to make a mistake. A primary resource is Twila Slesnick and John Suttle's IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out. The authors really explain the twists and turns for smartly cashing in on your retirement savings.

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TIPS: mutual fund or bonds

Question: I retired early and am over 55. I plan to keep enough money in my 401k to meet my needs until I'm 591/2. To take advantage of things outside of my former employers 401k plan, I'm planning to rollover the rest of the money into an IRA. One of the things I'd like to buy is TIPS (treasury inflation protection securities). When I do this, which is better, buying TIPS via a broker or financial planner where I have the IRA or putting the money into a TIPS mutual fund. So far, I did a quick review of both Vanguard & Fidelity's TIPS fund. P.E., Brandon, FL

Answer: As you know I am a big fan of TIPS--Treasury Inflation Protected Securities--in a retirement savings plan. TIPS are a savvy and safe way to preserve the value of your savings over time. It's a hedge against inflation gnawing away at the purchasing power of a dollar.

The low cost mutual funds you mention are extremely convenient to own and manage. Problem is, bond mutual funds don't have a specific maturity date. The money is always being reinvested in a basket of TIPS. This means that you'll never be quite sure what the payoff from the investment will be in the future. A TIP mutual fund still provides protection against inflation. But it's a more volatile option than owning the securities directly.

The advantage of buying the actual bonds is that you get to control the timing of your inflation-protected investment. You can purchase TIPS with different maturity dates: 5-year, 10-year and 20-year. Fluctuations in the market won't matter so long as you hold them till they mature. It allows for easy financial planning.

However, you can't buy TIPS directly from the U.S. Treasury in an IRA. (When you buy TIPS from the Treasury there are no commission costs.) You'll have to pay a brokerage commission or fee. It's a minimal charge with online and discount brokerage firms.

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The $6,500 tax credit

Question: I have a question about the recent federal tax credit for 1st time home buyer extension to cover move-up / repeat buyers.

All news and discussions talk about $6,500 for qualified move-up / repeat buyers. I moved from an old house to a new one in April. I lived in my old house for more than 5 years. Am I qualified for the credit? My realtor said yes but, when I checked the federal housing web site, it says only purchase after November 6 is qualified. I meet all qualifications except for my purchase date. Is there a date limit for the qualification??? Thanks, Joseph, Carrollton, TX

Answer: I don't like it. The $6,500 tax credit has several twists and turns, including income limits. Here is a good review of all the rules.

Anyway, to your question: The $6,500 credit applies to existing home owners "purchasing a principal residence after November 6, 2009 and on or before April 30, 2010 (or purchased by June 30, 2010 with a binding sales contract signed by April 30, 2010). " Sorry.

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Another credit report

Question: I have been requesting credit reports in tandem from one of the three agencies every fourth month. In this way, I receive a free report from each agency once a year. Would I jeopardize the free report privilege if my wife requested separate credit reports as well? Robert, Raleigh, NC

Answer: No, what you're thinking about doing is fine. It's a good idea for each of you to ask for your own free credit reports. (And to reiterate, the only place to apply for your free annual credit reports is from annualcreditreport.com. Jingles and ads notwithstanding, it's the official site to help consumers get their free credit report.)

Of course, much of the financial information will be the same, but not all of it. The way the credit reporting bureaus work, married couples don't share a credit report. You each get your own report. But the activity from your joint accounts will show up inn each.

I like what you're doing. You're getting a free report from one of the three agencies--Experian, Equifax, and TransUnion--every four months. Your wife can take a similar approach. But she could pick a different monthly pattern. For instance, let's say your reports arrive in January, May, and September. Well, she could choose to get hers in March, June, and November. This way you'll essentially have a running credit report tally for review covering much of the year.

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Refinance, or not

Question: I own a home which I'm in the process of refinancing under the Keeping Homes Affordable program. As part of the refinancing, the mortgage lender wants to subordinate my home equity line of credit (which is through a different lender - my bank) to the mortgage. In order to do this, my bank wants to lower my line of credit from $28,000 to $10,000 and they want to freeze it for the time being.

I'm very uncomfortable with this as it has been serving as my "safety net" to pay for unexpected expenses in the past year, which I know isn't ideal, but things have been challenging economically because I've had to take a 20% pay cut at my job for the past 9 months. In the long run, refinancing will save me thousands of dollars, but it will also extend my mortgage 5 years and could put me in a difficult situation if anything happens in the short term. What should I do? Laura, Minneapolis, MN

Answer: I understand your trepidation. Pay cuts are tough to absorb, especially when it's unclear when you'll get back to par. My bet is that it won't happen anytime soon. Companies are in no hurry to act with an unemployment rate of 10.2% and the broadest measure of underemployment at a record 17.5%.

That said, from what you've told us the refinancing is putting you on the path toward a stronger financial position. I would take the lower line of credit limit. I would focus on reducing your spending--yes, budget--to shore up your savings instead. Of course, it's always easy for me or anyone else to say "budget." It's always hard to make cuts in spending. Nevertheless, It will pay off for you to go over your spending carefully, see where you can nip and tuck, and add to your savings. The sums may not seem like much at first. But save a bit here and a bit there and all of a sudden your talking real money.

By the way, there should be no prepayment penalty with your mortgage. So, when your income and finances take a turn for the better you can always start paying off your mortgage more aggressively.

What do other members of the Getting Personal community think? Send Laura your thoughts and suggestions.

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Low risk and high yield?

Question: Over the past year I have saved about $3,500, stashing it in online savings accounts that are yielding lower and lower interest rates. My question is, what should I do with this money? I'm wary of putting it into tumultuous stock market, but CDs and other "safe" options are yielding abysmal returns. Is there a low-risk investment that would allow me to see a better return than 1.5 percent? Thanks! Casey, Portland, Maine

Answer: The interest rates on safe savings are paltry. It's hard to get much more than a fractional rate of interest on savings accounts, certificates of deposit, savings bonds and short-term Treasury securities. Little wonder many of the questions I get involve the desire for higher yields without abandoning the security of the federal government's full faith and credit. Fact is, you're not doing bad getting 1.5%!

It's an axiom of modern finance that you can only create the prospect for higher returns by taking greater risk. You've worked hard to save $3,500--congratulations. You say you're wary of putting it into the stock market since your $3,500 could plummet in value to $2,500 or worse if the stock market lurches lower. (Of course, it could grow in value if the rally continues.) You can pick up a higher yield by buying into corporate bonds, but there is still greater risk than in an online savings account or CD.

In most cases, my advice for now is if you don't want to embrace volatility stick with safety--and low yields. Eventually interest rates will rise when the economy is healthier and you'll be able to participate in those greater yields.

Another thought: Inflation erodes the purchasing power of savings. I'm skeptical that the outcome of the Federal Reserve's unprecedented efforts to prevent a financial collapse will end in a bout of hyperinflation as some Wall Street money mavens fear. Yet even if I am right, low rates of inflation still eat away at the value of a dollar. That's why many investors are adding to their portfolios securities that safeguard against inflation. You could put some of the money into I-bonds. It's a hedge against a rise in inflation and there's no credit risk.

Take Social Security now or later

Question: I am still employed and am almost 67 years young. Is better to wait till I am 70 1/2 to collect Social Security benefits or take them now? Barbara, Palos Hills, IL

Answer: Yes, you are young. By the way, question is whether you take it now or by age 70. The age 70 ½ date comes from when you have to start taking money out of a traditional IRA or 401(k). But there is no benefit to waiting past age 70 to start drawing on Social Security. That's when you reach the maximum payout.

I can't give you a definitive answer. A lot of factors play a role in dealing with your question, from earnings to taxes. But I can do one better. I can send you to the website with the best online Social Security calculator. It's analyzenow.com. It offers several simple but comprehensive Social Scurity calculators.

The website was created by Henry "Bud" Hebeler. He's quite a character. In 1956, he left Boston with a graduate degree in engineering from MIT for a job at Boeing in Seattle. Some three decades after he made that trip in a Volkswagen Beetle, he retired as president of the company's giant aerospace unit. It wasn't long before Hebeler started a new career dispensing conservative financial advice on his web site. And he has thought carefully about the trade-offs between taking Social Security at different retirement ages, ranging from early (age 62) to late (age 70).

A dollar collapse

Question: My husband's paranoid web sites are now predicting the collapse of the dollar by the end of the year. They say that other countries are no longer buying dollars and that the Fed is printing money like crazy to make up for the lack of foreign investment.

What do you think? If the dollar did collapse, what would that mean for the average citizen? Cheryl, Boulder, CO

Answer: The dollar has been weak in the international currency markets. At the moment, a weaker dollar has improved the competitive position of American exporters against their foreign rivals. I'm skeptical that we're seeing a "run on the dollar," however. For instance, the dollar rallied during the global financial crisis. The greenback is still the world's safe haven during times of trouble. So, some of the retreat in the dollar's value reflects a calmer mood among global traders.

I'm also in the camp that believes the Federal Reserve will be able to successfully mop up money in the aftermath of its extraordinary campaign to prevent another depression. It won't be easy or smooth, but I'm convinced the Fed is well aware of the problem ans has the intellectual and monetary tools to cope.

Still, the risk that the dollar will spiral sharply lower is there. We all know that the risk of catastrophe can't be simply dismissed simply because it's unlikely, not following the once "unthinkable" government takeovers of Fannie Mae, Freddie Mac, AIG, GM and Chrysler.

So, you asked what a dollar collapse might mean for the average citizen. Basically, it would be a disaster. My guess is that the financial markets would crater as financings denominated in dollars plunged in value. The price of oil and other critical commodities could skyrocket. Inflation would certainly take off. Americans would find it harder to borrow with the rest of the world wary of lending to us. After all, who wants to get paid back with depreciating dollars? Interest rates would sky rocket. The Federal Reserve would feel forced to tighten monetary policy to stem to panic. Trade wars could erupt. And so on.

Peter Coy of Business Week has a good article directly looking into your question, What Happens if the Dollar Crashes. You can read it here.

ETFs

Question: I've just opened a Roth IRA to start saving for retirement. However, as a graduate student, the amount I'm starting with and able to contribute monthly is well below the minimum investments for various mutual funds. I've been looking at ETF's, which seem to have the same diversification with lower expense ratios. Is there a reason to prefer one over the other that I'm not seeing? Thanks much. Drew, Atlanta, GA

Answer: The exchange traded fund (ETF) is a genuine innovation. ETFs are investment vehicles that track indexes but an ETF is traded like a stock. The most popular ETFs are based on broad stock indexes such as the S&P 500 and the Dow Jones Wilshire 5000. There are also a number of broad-based socially responsible ETFs. It's also another way for the small investor to take a plunge in windmill energy, solar and other energy alternatives.

Problem is, there has been an explosion of ETFs that slice and dice the market into smaller and smaller and smaller pieces. Intrigued by patents? There's an ETF for you. Think the Austrian economy is poised to rebound? Yes, there's an Austrian ETF. That's why I'm cautious with ETFs in general. It's a product increasingly designed for speculation, not investing.

That said, an ETF is fine if you want to buy a broad-based index all at once. You pay the brokerage fee, and then hold on to the investment. An ETF works for a buy-and-hold strategy. But a no-load equity index mutual fund is better if you're adding to the investment in small increments over time, say, $100 a month or a similar investment disciple.

Inflation indexed bonds

Question: Is there a way I can buy "I" series treasury bonds with pre-tax money? I would like to hedge a little bit against inflation with these bonds, but don't like buying them with after tax dollars. Does this make sense? I am open to suggestions. Jeff, Sparta, TN

Answer: Let me clarify the choices. In an IRA or comparable retirement savings plan you can't buy Treasury Inflation Protected Securities directly from the U.S. government. However, you can purchase them through a broker with pretax dollars in an IRA, 401(k), and the like. (And commission costs are low.) You can also buy mutual funds that invest in TIPS with pretax money.

The I-bond is a savings bond that also offers investors an inflation hedge. It is purchased with after-tax dollars. But the money compounds tax free until you cash them. You don't want to buy I-bonds with pretax dollars since it's already a tax-sheltered form of savings.

Both TIPS and I-bonds are good long-term investments for savers.

Stock options

Question: My husband is a mid level executive and he receives stock options yearly as part of his compensation. Since the stock prices have been continually declining at his company, we now have five year's worth of options we are unable to exercise. Aside from the stock price increasing, is there any way we will be able to recoup this money? Mary, Milwaukee, WI

Answer: Your husband's situation isn't uncommon among publicly-traded companies. Many executives now hold stock options that are worthless because the "exercise" price is greater than the market value of the underlying stock. In other words, you'd lose money if you exercised the options. The Wall Street metaphor for this experience is that the options are "underwater". Descriptive, isn't it?

There's nothing your husband or you can do. It's really up to management and the board. They can decide to leave the current option awards program unchanged. In that case, everyone will have to wait and see if the stock price improves before the option grant expires. The employee optionholders remain in the same financial boat as shareholders. However, some companies have decided to take a different tact. They are rewarding employees by substituting their old underwater options for newer ones with a lower exercise price, retiring the options and issuing restricted stock, or by exchanging cash for the options.

Military thrift plan

Question: Hi, I recently left active duty military service and am trying to decide what to do with my Thrift Savings Plan. I've got about $40k saved in it right now.

When I look at the options for withdrawing, it seems like I'll be paying either 10 or 20 percent penalty fee.

I was thinking about starting a ROTH IRA. Should I take the penalty and roll it over into a ROTH IRA? Or am I better off just letting the money sit in the TSP until I retire? Thanks, Spencer, Humble, TX

Answer: You have a number of good options to think through. And you shouldn't pay a penalty or taxes with them. The one exception on taxes is the Roth option. I'll explain in a moment.

First of all, the Thrift Savings Plan is a really good, low-fee plan. It's hard to beat. You might want to simply leave your retirement savings in the plan.

If you still want to move your savings out of the Thrift Savings Plan you can roll it over into another tax sheltered plan. For instance, if your current employer's savings plan allows it you could transfer the money into your new 401(k). Alternatively, you could roll it over into an IRA. In both cases you don't take the money out. You'll make an institution to institution transfer of the money, preserving its tax-sheltered status. No penalties will be imposed, either.

You could put the money into a Roth-IRA. Since the Thrift Savings Plan was funded with pre-tax dollars and a Roth is funded with after-tax dollars you'll owe taxes on the money your transfer into the Roth. However, when you pull the money out during retirement the gain is free of Uncle Sam's levy. By the way, in most cases it does not make sense to Roth if you have to use your retirement savings money to pay the tax levy. It reduces the amount that can grow, free of tax, in the Roth.

I'm not sure which branch of the military you served in. But the Navy offers a clear brief explanation of your choices.

Responsible for debt

Question: In 1999 I opened a credit card with my nanny to help her establish credit. I have never used the card so all of the charges on it are hers. Last year in July I was informed by the bank that she was late on a payment. I canceled the card. Since then she had been paying regularly until this past May. She is over 90 days late and it is now in collection. I had her fill out a form to assume financial responsibility for the card. The bank will not allow that because she has been late. Technically it is my responsibility. The total due on the card is around $10,000. What can I do so this doesn't ruin my credit? Vivian, San Mateo, CA

Answer: I know you don't need me to say this at the moment, but for other listeners and readers your experience is why it doesn't pay to co-sign or open a joint account with non-family members--no matter how trustworthy. Life intervenes, and many of us fall behind on our payments for a number of reasons. (Even with family members I urge caution; there are other ways to help them out financially without taking on a legal obligation.)

Fact is, the bank and collection agency has every incentive to enforce your legal responsibility for the payments. You can't get off the financial hook. Still, the good news is that you've closed the account. The potential damage is limited to the $10,000 remaining on it. Now that it's in collection the simplest way to minimize any damage to your credit is to pay it off and then work out a payment plan with your nanny. Of course, this course of action depends on your relationship with your nanny.

Does anyone else have a suggestion?

Investment taxes

Question: Hi Chris, I have listening to Market place Money for the past several years and love to hear your views on the economy and your Q&A. Last year I bought some Municipal Bonds (MICHIGAN ST BLDG AUTH REV BDS CUSIP 594614W54) when the financial world was coming to an end (:((). I just did this as an experiment. (The post tax yield equivalent on these bonds were attractive at that time) If I were to sell these bonds after a year of holding them - what are the tax implications? Thank you and look forward to hearing your views in these historic times. Guru, Farmington Hills, MI

Answer: With the scenario you've laid out you would come under the capital gain and capital loss rules. You say you've owned the bonds for more than a year. Let's assume for illustration purposes that you paid $10,000 and you can sell the bonds for $10,400. You would have a capital gain of $400 with a maximum rate of 15%. (A long-term capital gain requires that the security be held for more than 12 months; the maximum rate on short-term capital gains is 35%.)

However, if you sold the bonds and could only get $9,800 for them you would have a capital loss of $200 that can be used to offset, first, a long-term capital gain and, second, if there is any loss left over any short-term capital gains.

Of course, there are a few other wrinkles, such as adjusting for selling costs and whether the bonds were sold at a discount. But that's the basic idea.

Thanks for listening.

Buy a home

Question: My wife and I are considering buying a home in San Francisco, but also know that we will be moving to LA sometime in the 3+ years. Homes in SF are extremely expensive, and we would be able to put down a 15%~20% down payment, but I don't want to lose this money if the market gets worse. We are both currently employed luckily and are expecting which is what is prompting this decision. What tools are out there to help us make a smart decision on whether this is a financially smart idea? Also if we do buy a home, when we move what are the consequences of renting out the home?

Thanks in advance and love the show. David, San Francisco, CA

Answer: I would be very wary of buying with your time frame of 3-plus years. Whenever I run the numbers it's clear the longer you intend to stay in a home the better the financial advantages of ownership. It's safe to say that if you plan on staying in a place for three years or less renting is always preferable. I don't think ownership makes sense unless you're confident that your time horizon is at least 5 years, and preferably longer.

It does appear that the housing market is stabilizing. That doesn't mean it won't stagnate for a long period of time in many markets. It's what I expect. In coming years, the ebb and flow of home values will largely be dependent on local job and income growth. In the words of a Business Week story on the housing market, it will be "back to blissful boredom." It will be a welcome respite.

Still, it's always a good idea to run the numbers. Online calculators will do the math for you. There are a number of good ones, but I tend to gravitate toward the websites dinkytown.net and hsh.com. By playing with different assumptions these calculators will help you figure how long it might take before you break even on the investment or, to put it somewhat differently, how much risk you're taking with the down payment money.

When you rent out a home you are no longer a homeowner but a small business person. It's a business. Nolo.com is a good source on what it takes to be a landlord.

Roth conversion

Question: My wife has a combined income that is over the limit for a traditional IRA tax deduction or for contributing to Roth directly. We both also have employer sponsored retirement plans. Since there is no income limit for conversion from a traditional IRA to a Roth in 2010, I want to establish a traditional IRA now so that I can convert it to Roth next year. My question is, because I will be contributing to my traditional IRA after tax (or without any tax deduction), how I will be taxed when I convert my traditional IRA to a Roth coming 2010? Thanks. Andrew, Norman, OK

Answer: What you're planning on doing can be a smart move. Let me just give a bit of the background behind your question.

The Roth-IRA is a terrific retirement savings vehicle, probably the best available. The main reason is that all accumulated investment gains are free from Uncle Sam's clutches when withdrawn during retirement. The other attraction of the Roth is that it offers unusual flexibility for managing finances. For instance, there is no required minimum distribution at age 70 ½ with a Roth as there is with a 401(k) or a traditional IRA.

In the past, you could convert money stashed in a traditional IRA into a Roth, but you could only do it if your adjusted gross income was under $100,000. That earnings cap on conversion disappears next year. That's why the Roth conversion equivalent of a gold rush is about to be unleashed in 2010. Conversion calculators have sprung up all over the web. (The contribution limits to a Roth and the income phase-outs all remain essentially the same in 2010 and on. What have changed are the rules with conversion.) There are a lot of twists and turns to the Roth conversion question in 2010 and after. But it's an issue well worth researching.

Now, to your question. Many financial planners I've talked to are advising folks that earn too much to contribute to a Roth and a traditional IRA to open up what is called a non-deductible IRA. This is what you're planning to do. The non-deductible IRA is funded with after-tax dollars. The gain is tax-sheltered over the years and the earnings are taxed at your ordinary income tax rate on withdrawal during retirement.

But you're not going to wait that long. You'll convert the non-deductible IRA into a Roth in 2010. The only tax you will owe on conversion is on whatever gain you've earned in the meantime--in other words, not much. You won't owe anything on the contribution since you've already paid the tax tab on that money. And, of course, with this maneuver you won't pay any taxes on the investment earnings when you withdraw the money in your retirement years.

As I said, it can be a savvy move.