Situation, emotions dictate best steps to take

PERSONAL FINANCE

January 14, 2001|By EILEEN AMBROSE

Financial planners say clients often have the same questions, but the answers can be very different.

One client may be better at dealing with risk than another, or one person has no debt, while another is swimming in red ink.

Below are some of the most frequently asked questions that planners receive and some of their answers. While there's no one-size-fits-all solution and likely an exception to every rule, the answers reflect considerations that many consumers will need to evaluate when choosing the best option for them.

Do I pay off credit card debt or invest in my 401(k)? Ideally, do both, planners agree. At least, invest enough in the 401(k)to get the employer's full match, which is free money, and put extra dollars into wiping out plastic debt.

But if an individual can afford only one option, or the employer doesn't offer a match, then get rid of the credit card balance, said Kevin Condon, a certified financial planner with Baltimore-Washington Financial Advisors in Ellicott City. "If you stay in debt, the cost of your debt service is eroding all that you would be making on the other side," he said.

Do I pay off my mortgage or keep the loan and invest the money instead? For some, the peace of mind of owning a home outright trumps other considerations. Others, though, need to do the math to figure where their dollars will do the most good.

First, determine the interest rate you pay on the mortgage after factoring in the benefit of deducting interest payments off your income taxes, said Barry Glassman, a certified financial planner with Cassaday & Co. in McLean, Va. Compare that with what your money earns after taxes on investments and bank accounts, he said.

If the return is higher on your investments and other accounts, continue putting dollars in those areas while gradually paying off the loan, Glassman said. But if you have big balances in low- or no-interest bearing checking accounts, you're probably better off getting rid of the mortgage, he said.

Some planners recommend paying off a mortgage before retirement, while others suggest retirees keep the loan if eliminating it would cause liquidity problems.

Should I invest for my children's college education through accounts in their names? Often parents establish custodial accounts in children's names because of the tax advantage. Income generated by the accounts are taxed, if the children are 14 or older, at the youngsters' likely lower-income tax rate. The major drawback: The money belongs to the children, and once they come of age, which is 21 in Maryland, they can take control of it.

But Glassman says the tax advantage of custodial accounts may not be worth the control parents give up. One child with a sizable account may win a full scholarship, while a sibling's account hasn't grown enough to cover high-priced tuition, he said. Parents don't have the ability with custodial accounts to shift dollars from one child to another as needed, he said.

And besides, Glassman said, the new capital gains rate lessens the custodial accounts attractiveness. For those in the 28 percent or higher income tax bracket, securities bought beginning this year and held for at least five years will be taxed at an 18 percent, rather than 20 percent, rate.

He recommends parents save for college by buying tax-efficient investments in their own names or investing in one of the 529 plans offered by many states that provide tax breaks yet give parents some control over the assets.

How much insurance do I need? You could read a book on this subject, but here are the CliffsNotes: Buy life insurance if you have someone dependent on your income or you want the proceeds to pay your estate taxes, said Peg Downey, a certified financial planner with Money Plans in Silver Spring. If that's not you, then save enough money in an emergency fund to pay for your burial and forgo life insurance, she said.

If buying life insurance, check out TIAA-CREF's online calculator (www.tiaa-cref.org/lins/howmuch.html) to figure the amount of coverage needed, Downey said.

Unless you have plenty of money to retire on now, you will need disability insurance, Downey said. After all, a disability is a "forced retirement" with probably higher medical bills, she said.

Should you buy long-term care insurance? "If you are not really poor or really rich, probably yes," Downey said. Make sure, though, if you buy a policy, which can be pricey, that you can afford the premiums on your retirement budget, she said.

Should I invest in an Individual Retirement Account? Invest in a traditional IRA if you are allowed to deduct contributions off your taxes, said Deborah Voso, a certified financial planner with Voso Associates in Frederick. If not, she said, invest in a Roth IRA, where you put after-tax dollars into the account and years later at retirement withdraw the earnings tax-free. Or, if you qualify for only a partial deduction in a traditional IRA, split your contributions between the traditional and Roth IRAs, she said.

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