“All credit scores are FICO scores.”
The most widely-used credit score model is FICO (Fair Isaac Corporation). Most lenders do use FICO, but you have three different FICO scores from the three major credit bureaus—Experian, TransUnion, and Equifax. Many lenders use their own credit scoring system, which often includes the FICO score as well as other information. A good place to learn more about credit scoring in general is www.myfico.com.

“Carrying a big balance helps my credit score.”
Not so. It’s true that a history of good debt management gains you a higher score than having no debt at all, but the less outstanding credit you have, especially on credit cards, the better. And paying on time is critical. In fact, if you run up an especially-big credit card bill in any given month, try to pay it off a few days early, because outstanding debt is reported to the credit bureaus at the end of the month.

“Wiping out a delinquent debt will immediately fix my score.”
Unfortunately, negative information on your credit report is slow to disappear—seven years for credit delinquencies and ten years for bankruptcy information. It’s far better to avoid credit trouble in the first place.

“I should close my accounts as I pay each one off.”
Closing accounts can actually hurt your score, because credit bureaus look at your “utilization ratio” of credit used vs. credit available. A closed account has zero dollars available, so it’s better to keep your accounts open and only charge (then pay off) one or two small amounts each year. Another reason to keep accounts open is that your score considers both the average age of all your accounts and the age of the oldest one. If you do want to eliminate a line of credit, call or write the lender to ask that your account be closed “at the cardholder’s request,” with written confirmation.

“I only use cash so my score must be great.”
Unfortunately, no. You must use credit to build credit and demonstrate that you pay your debts. Living on cash only doesn’t establish a payment history, and that could be a problem when you want to buy a house or car.

This One’s No Myth
To maintain a good credit score, pay your bills on time, keep your total debt low in proportion to your available credit, and review your credit report regularly to look for errors. Also remember that it’s not only the number of your credit score that’s important, but also the information contained in your report. Be sure to review your credit report from all three reporting agencies annually at AnnualCreditReport.com.

Financial preparedness is especially important if you (or your spouse) are the sole breadwinner. According to the Bureau of Labor Statistics, in 2007 there were 58 million “married-couple families” in the U.S. In just over half of them, both husband and wife worked. That percentage has been falling ever since. The Center for American Progress found that in 2010 alone, more than 1 million two-earner married couples were reduced to one earner.

With more American families now relying on one income, it’s important to plan for the unlikely and unexpected death of the sole breadwinner. The last thing you want to do while grieving the loss of your spouse is sell the family home, get a second job, or impoverish yourself to pay for medical bills and living expenses. Here are some steps you can take now to help avoid a financial crisis during an emotional tragedy.

The Truth About Life Insurance

Most people have life insurance, and most life insurance policyholders believe they have an adequate amount of coverage. Unfortunately, many policyholders are wrong. Only a minority of surviving spouses describe their life insurance payouts as adequate.

The problem is one of perception. Many people have life insurance through their employer. Because these families know they have at least some insurance, they believe they’re prepared. But employer-sponsored life insurance is rarely enough to help a family maintain its standard of living. Once the life insurance proceeds are gone, most families with only employer-sponsored coverage have to start making serious changes in how they live and work.

Assess Your Needs

You can begin with an objective look at what your family needs right now to get by. Do you have dependents, such as young children, a non-working spouse, or parents? How much money do you need to pay the bills and send your kids to college?

When planning for a tragedy such as the premature death of a spouse, it’s particularly important to establish this baseline because a terminal illness could drastically increase your expenses. The death of your spouse also means the loss of that spouse’s health care coverage.

When considering how much life insurance you need, you should also factor in lifestyle changes you anticipate in the near future. Do you plan to have a baby or buy a larger home? Are your aging parents becoming increasingly dependent? Are you considering sending a child to private school? Perhaps you anticipate a more sophisticated lifestyle in the future as your income increases.

You can’t anticipate every future lifestyle change, but you can provide your family with life insurance coverage sufficient to meet their needs. You can review your policy riders, options, and beneficiary designations at regular intervals and purchase additional coverage or make changes as needed.

Evaluate Your Resources

Life insurance may not be your only source of support. Take stock of other assets that may be available to you:

• Investment accounts that can be accessed to meet the family’s changed circumstances
• Retirement accounts that can be earmarked for the surviving spouse’s retirement years
• College savings accounts
• Social Security Survivors Insurance (based on your spouse’s work history)
• Family resources (wealthy relatives who would be willing to release part of an inheritance early)

Understand Your Finances

Ideally, both partners should know where their money comes from, where it goes, how to pay the bills, and have an understanding of investment accounts. You should also understand your spouse’s employer-provided benefits. If you or your spouse has taken a backseat in the management of the family finances, it’s time to take a more active role. It’s better to learn your cash-flow picture now, instead of when you’re forced to understand at a time when it will be much more difficult.

Preparation is Best

A surviving spouse will have a lot of financial issues to address. It’s best to address them well in advance. A financial professional can guide you through the difficult questions you should ask to prepare for an event that, hopefully, will never occur.

Start with a Plan

Begin by making an estate plan and update it as your circumstances change. This should include a will with specific directives for both your child and yourself. If you’re incapacitated, you might be unable to make decisions for your child. And if you don’t plan for your own retirement and health care needs, you might not be able to help them as much as you’d like.

Next, consider the guardianship/conservatorship process to take legal/financial control of your child’s life. This generally terminates at age 18, after which your child might need a trustee or other protections to carry them through adulthood and past the deaths of their parents.

Your child’s assets are a vital consideration. A child with more than $2,000 of total assets in his or her name cannot qualify for federal benefits such as Supplemental Security Income (SSI). This is especially crucial because in most states SSI recipients are automatically eligible for Medicaid.

The Special Needs Trust

The answer to the assets problem is the Special Needs Trust, set up to accumulate, manage, and disburse monies for a child with a disability. The trust holds assets (including money won in a lawsuit about a disabling incident) that are not considered to be personal wealth. The trust can also be the beneficiary of any inherited assets. With a few limitations, this won’t affect the child’s eligibility for government benefits.

A Special Needs Trust must be created and funded by a third party, such as a parent or grandparent. The trust can be established during your lifetime or through your will. Ideally the trust should be set up before your child turns 18, but it works at any age. The disabled person should not create the trust, fund it with his own assets, or have any control over it. The trust must be administered by an independent trustee with the authority to make discretionary non-support distributions. To avoid jeopardizing government benefits, trust payments must go directly from the trust to service providers.

Your Special Needs Team

It is important to identify specialists who understand the complexities of the unique needs of your child. Here’s a quick checklist:

• An attorney is required to set up a Special Needs Trust. Look for one with expertise in this area.

• A social worker can help you seek out benefits programs, public and private, that provide resources for special-needs situations. In addition to federal programs, look for state and local resources.

• An attorney or social worker with expertise working with special needs children can help you draft a “letter of intent” that communicates your family’s vision, desires, and concerns for your child to current and future caretakers.
• A guardian should be identified who will step in if you become unable to make decisions for your child and to take over after you die.
• Peer groups for families in special-needs situations can be a good source for professional referrals and service recommendations, plus common sense advice and reassurance that you’re not alone in facing this challenge.

Finally, it’s important to get sound financial advice. A person with special needs may not be able to work or save for retirement, and they often have state restrictions on their investment options. Find a financial advisor you trust to plan a secure future for your special needs child.

Understand your insurance coverage. Is your homeowner’s policy based on the highest replacement value for your neighborhood? What about flood insurance? Does your insurance cover temporary relocation and car replacement? Understanding the answers to these questions is essential so you know what to expect if a disaster strikes.

Inventory your possessions. Documentation is crucial for insurance claims, so record the value of each item and keep photographs or video recordings. Your inventory should include detailed descriptions, noting model and serial numbers where available. Collect receipts and get appraisals for valuables such as jewelry, heirlooms, antiques and artwork.

Also note any renovations to your property, such as a remodeled kitchen, and be sure your homeowner’s insurance reflects the value of these improvements. Record items outside the house, too—vehicles, sporting goods, and improvements such as a new fence or deck. Once your inventory is complete, store one copy in a safe deposit box, one at home, and one with a distant friend or relative.

Rent a safe deposit box for your home inventory, home and vehicle deeds, birth certificates/naturalization papers, passports, insurance policies, investment certificates, marriage certificates and powers of attorney. Add a copy of your will, but keep the original at your attorney’s office or registrar of wills. Consider a safe deposit box in a distant bank, away from any local disaster.

Assemble an “evacuation box” of important documents. It should be strong and lockable, with self-sealing, waterproof plastic bags. Keep it indoors near an emergency exit and include:

• Key to the safe deposit box
• Cash/traveler’s checks
• Phone numbers for yourself, family, friends, insurance agents, attorneys, financial advisors and doctors
• Account numbers for banks, credit cards and investments
• Social Security and driver’s license numbers for all family members
• Copies of your safe deposit box contents
• Copies of your last three tax returns
• Current backup of your computer files, including precious photos
• Medical prescriptions

Get everyone on the same page. Develop a “what-if” list of scenarios that could jeopardize your family, your home or your income. Talk with your family and make a plan for how you will react—where you will meet and what you will bring with you. Make sure everyone understands the basic plan in the event of an emergency.

Charitable Remainder Annuity Trust (CRAT) or Charitable Remainder Unitrust (CRUT)

• CRAT – The donor transfers an asset to an irrevocable trust and receives a fixed dollar amount each year thereafter.
• CRUT – The donor transfers an asset to an irrevocable trust and receives a set percentage of the trust’s value each year thereafter.
• With both CRATs and CRUTs, a current income tax deduction is also available.
• With both, when the donor or named beneficiary dies, the remaining trust assets pass to the charity.

Charitable Lead Annuity Trust (CLAT) or Charitable Lead Unitrust (CLUT)

• CLAT – The donor transfers an asset to an irrevocable trust, which pays the same fixed dollar amount each year thereafter to a charity.
• CLUT – The donor transfers an asset to an irrevocable trust, which pays a fixed percentage of the trust assets as valued each year thereafter to a charity.
• With both CLATs and CLUTs, a current income tax deduction is generally allowed for the present value of the income interest paid to the charity.
• With both, at the end of the term of the trust, the remaining assets pass to the donor’s heirs, spouse, or sometimes back to the donor, if living.

Pooled Income Fund (PIF)

• The donor transfers an asset to the trustee of the PIF and receives a proportionate share of the trust’s income for each year thereafter.
• A current income tax deduction is also available.
• When the donor or named beneficiary dies, the remaining trust assets pass to the charity.

Charitable Gift Annuity (CGA)

• The donor transfers an asset to a charity and receives a fixed dollar amount, set at the time the gift is made, each year thereafter.
• A current income tax deduction is also available.
• When the donor or named beneficiary dies, the charity has no further financial obligations to pay.

As you can see, it’s possible to help your favorite charity and yourself within your lifetime. As you can imagine, these details and decisions call for expert advice. If you’d like to explore planned charitable giving, I’d be happy to coordinate the best professionals to help you.

Fortunately, advance planning can take the sting out of RMDs. In fact, you could look at RMDs as an unexpected opportunity when designing a tax-smart retirement withdrawal plan.

RMDs in Action

Let’s consider an example of a retiree with $1 million in her IRA accounts who will turn 70½ in 2012. Under existing rules, she must take her first RMD by April 1 of 2013, based on her IRA balance at the end of 2011. Her RMD would be roughly $36,500. But she also has to take her second distribution by December 31, 2013, based on the total IRA balance at the end of 2012.

If she follows the natural inclination to delay her first RMD until April 1, 2013, it could make her tax situation worse. She would then receive two distributions in the same year. This extra income would most likely boost her into a higher tax bracket and potentially cause her to pay higher Medicare Parts B and D premiums. It might also expose more of her income to the new 3.8% Medicare tax, which will take effect in 2013.

Meeting the RMD Challenge

Though you face mandatory distributions at age 70½, you don’t have to wait until then to find the best strategy for you.

One option you have is to withdraw money from your IRA before the distributions are required. For example, a retired couple in their 60s could withdraw just enough from their IRA to keep within their 15% or 25% income tax bracket.* They could use that money to pay for living expenses rather than drawing Social Security. Delaying the start of Social Security benefits will not only result in a higher benefit payment when you do start, but may also lower your income taxes in retirement.

Up until December 31, 2011, another way to lower potential RMDs in retirement was to make gifts of up to $100,000 from your IRA to your favorite qualified charity. These distributions would not increase your gross income. This may be an option again in the future, as some Congressional leaders hope to pass a retroactive extension of this tax provision.

A third method is to convert a traditional IRA to a Roth IRA, which is not subject to mandatory distributions. Some people have concerns about Roth IRAs because you pay taxes on the amount of the conversion in the year you make the conversion. Keep in mind, though, that once you’re over this hump, distributions from your Roth IRA are generally not taxed.* And Roth IRA assets can grow tax-free, even beyond the owner’s death.

Don’t Let RMDs Sneak Up on You

Planning for the potential consequences of RMDs long before you have to deal with them can help keep your Social Security benefits out of the income tax stream and shift your income from a higher to a lower tax bracket. If you are nearing retirement, let’s discuss your Social Security and long-term tax planning opportunities.

*If you are contemplating withdrawing retirement funds before age 59½, remember that retirement accounts have regulations and penalties that may apply to early withdrawal.

A Different Animal

The either-or question (college or retirement) masks the fact that these are two different types of financial goals. Consider:

• College-bound students can seek out scholarships, grants and loan programs. But the security of your retirement depends entirely on you.
• Young people have a lifetime ahead of them to earn, save, and pay off debt. But if your kids are nearing college age, there isn’t much time left to fund your golden years.
• A college student’s income tends to rise steeply after graduation. The same may not be true of your income after retirement.
• Contributing toward college costs can build a child’s self-esteem. Running short of money in old age will do nothing for yours.

Starting Early

If your kids are still small and your income is sufficient, you may be able to save for both college and retirement. However, funding your retirement first and fully is critical to your own financial security—and to your long-term ability to help your children. By all means start saving for those diplomas down the road, but not if it means short-changing your own future.

Once your retirement savings program is firmly in place, don’t just open a bank account. Better choices may include 529 Plans, which allow savings to grow tax-deferred and offer tax-free distributions; Coverdell Education Savings Accounts, more limited in contribution level but applicable to elementary and secondary school expenses; and trusts to benefit a minor, which are popular with grandparents who want to help with college costs while possibly minimizing estate taxes.

Coddle Your Nest Egg

If you can’t easily manage both retirement and college savings, focus on tax-advantaged retirement plans. Many employers match some part of 401(k) retirement contributions. If you cease contributing to yours to save for college instead, you’re leaving that match money on the table. Another benefit to retirement plans is that you’re less likely to dip into the money for short-term needs over the years.

Even more important, assets in IRAs and similar plans generally aren’t included when the federal government and individual colleges and universities calculate your Expected Family Contribution (EFC) to education costs. It makes sense to contribute as much as you can to these accounts.

If tuition bills are looming and you’re short of cash, think very hard before tapping those retirement savings. Although funds in an IRA may be withdrawn penalty-free to pay qualified educational expenses, the entire withdrawal is regarded as family income for purposes of student aid. Cracking open that nest egg could damage both your retirement and your child’s chances for financial assistance.

A Parent’s Best Gifts

Encourage your kids to take some responsibility for college costs, whether it’s setting aside summer job income, researching scholarships, planning to take out student loans, or a combination of these. The sense of involvement and accomplishment this brings can be a great gift. An even greater gift will be the peace of mind your children will enjoy, knowing that their parents have crafted themselves a comfortable future.

From a federal income-tax standpoint, an HSA offers you several benefits.

• Within limits, your HSA contributions are tax-deductible (or pretax under an employer’s cafeteria plan).
• The earnings on your HSA investments accumulate tax-deferred.
• Your HSA withdrawals used to pay qualified medical expenses are tax-free.
• Any withdrawals you make for unqualified expenses are taxable, and a 20% penalty may also apply. However, there’s no “use it or lose it” rule as there is with a flexible spending account. If you don’t spend all the funds in your HSA account, you can let them accumulate in the account for future use.

Additionally, the amount you can contribute to an HSA increased in 2012.

If you are covered by a high deductible health plan, consider making the most of this savings opportunity.