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Financial Planning

Answers to Your Finances Questions

Are you saving enough for retirement? Do you have enough life insurance? Should you lease your next car? Here are answers to some of your most common investing, planning, money management and spending quesitons.

Kiplinger's experts take on the major dilemmas of your financial life -- where to invest now, how much insurance is enough, how to prepare for retirement, the best way to save for college -- and wrestle them to the ground.

Credit & Banking, Taxes and Insurance FAQs appear below. Use the links in the box below to jump to more.

Credit & Banking

Insurance

Taxes

Credit & Banking

My credit score is a mess. How can I clean it up?

Pay your bills on time. Your payment history accounts for 35% of your total credit score, according to Fair Isaac, the company that compiles the scores that most lenders use. Another 30% of your score is based on how much you owe. Owing some money is fine, but if your balances are too large, lenders worry that you're overextended and won't be able to repay them.

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About 15% of your score is based on how long you've had a credit history; the longer, the better. Avoid closing a lot of old accounts or opening several new ones because that will lower the average age of your accounts. New credit makes up 10% of your score; lenders worry that you'll borrow too much money if you've recently opened a number of new accounts.

Finally, 10% of your score is based on your mix of credit cards, mortgages, installment loans and other debts. Lenders are most interested in your history of managing credit card debt.

Your credit score is based on information in your credit report, so it also helps to contact the three credit bureaus -- Equifax, Experian and TransUnion -- to make sure your reports are free of errors that could lower your score.

How can I reduce the flood of credit card offers I get in the mail?

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Call 888-567-8688 and opt out of preapproved offers. As it is, most households receive an average of five credit card offers per month, and half of all college students get solicitations on a daily or weekly basis.

I have a spare $2,500. Should I pay down my credit card balance or add it to my retirement savings?

At first blush, it would seem that paying down your card balance is the better move: Fixed-rate credit cards are averaging 12.5% and variable-rate cards close to 12%, which certainly outpaces current returns on stocks and alternative investments. And you'd see your card balance drop by $2,500 overnight.

But that advice assumes you're not going to run your balance right back up again. If your spending is out of control, $2,500 won't make much of a dent in your debt repayment; you'd also be wise to get rid of your cards altogether or seek credit counseling.

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Your decision also depends on the size of your retirement kitty. Once you have made a good start, you can afford to divert $2,500 to paying off debt. But if you have saved little or nothing, you might be better off putting some or all of your spare cash into a retirement account, where it will begin to grow. That's especially true if you have access to a 401(k) account with a company match -- a guaranteed return that far exceeds the interest on even a high-rate credit card.

Should I take out a home-equity loan to pay off my credit card debt?

On paper it's a great idea to trade in high-interest, nondeductible credit card debt for a lower-interest home-equity loan, or to borrow extra money when refinancing your house -- especially because the interest on up to $100,000 in home-equity debt is tax deductible.

In practice it works only if you actually pay off your debt and don't run up even bigger balances -- putting your house at risk.

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I never got a credit card while I was in college. Now that I've graduated, what's the best way to get one?

Get a secured card. You'll have to deposit between $100 and $500 in a savings account to acquire a line of credit equal to that amount (a few issuers offer credit limits that are double the deposit amount). You'll earn interest on your deposit, but you won't be able to withdraw your money until the account is closed.

Nearly every secured card charges an annual fee, but you should never pay a processing or application fee. Interest rates run from 10% to 30%, so shop carefully (go to www.cardlocator.com).

Make sure the issuer will report card activity to all credit agencies (so that you can build a credit history) and will let you upgrade to an unsecured card after a year of making regular on-time payments.

Where can I get a checking account for my teen?

Start with your own bank, and don't be too quick to take no for an answer. Banks are reluctant to open an individual account for anyone under 18, but they're often willing to open a joint account with you as a co-signer. Credit unions are also a good bet.

In the 12 states served by KeyBank, your teen can apply online for a Key Student Checking account, which the bank is promoting to 16- and 17-year-olds with a parent as co-signer.

Insurance

Am I covered if ...

... a tree falls on my house? Yes.
... my neighbor's tree falls on my house? Yes, but it will be under your insurance, not your neighbor's.
... my basement floods? Not unless you have special flood insurance. Even then, your coverage won't pay for damaged drywall, furniture or carpets in a basement room.
... there's an earthquake? Only if you have earthquake insurance.
... there's a nuclear accident nearby? Sorry.
... a volcano erupts? You're in luck.

At what age should I consider buying long-term-care insurance?

The suggested age used to be 65, but go ahead and buy it earlier if you can afford the premiums and want the peace of mind.

There's no advantage to waiting to buy coverage because rates increase every year with your age, and new policies are priced about 20% to 40% higher than they were just a few years ago. No matter when you buy, you'll probably end up paying about the same amount over your lifetime.

For example, if you purchase insurance today at age 55 for a fixed premium of $900 a year and don't need care until age 80, you'll have spent about $22,500 in premiums. But so would a 65-year-old who buys a policy today with an annual premium of $1,500. Buying earlier means you forgo investing elsewhere, but you'd be buying an extra ten years of protection.

The bigger question is whether you can afford the coverage. Before buying long-term-care insurance, take care of more immediate financial needs--adequate life and disability insurance, an emergency fund and retirement savings. When you no longer need life insurance to protect your family, drop that coverage and shift premiums to a long-term-care policy (to shop for rates, go to www.ltcq.net).

If all medigap policies with the same designation offer the same benefits, how do I pick the best policy?

After you've chosen the plan you want (designated by letters A through J), all you need to do is look at price. Because medigap plans are standardized, every plan with the same letter designation offers the same coverage. Service rarely varies from company to company, so paying higher premiums won't get you any extras (shop for policies through your state insurance department).

But don't just buy the policy with the cheapest premium. Look first at how companies set prices for different types of policies.

With attained-age policies, premiums start out low but increase as you get older -- typically jumping every one, three or five years, in addition to price hikes resulting from health-care inflation, which are common to all policies. Issue-age policies base your premium on your age at the time of purchase. Rates will rise with health-care inflation, but they won't increase just because you get older.

Community-rated policies are similar to issue-age policies, except that everyone in the same geographic area pays the same price regardless of age (AARP generally offers a member discount of up to 20% for those under age 68).

It's usually best to go with the lowest-priced issue-age or community-rated policy, even if premiums cost a bit more at first. You won't have to worry about rates going up every year.

How much life insurance do I need?

The old rule of thumb is imprecise but useful: Buy insurance equal to six to ten times your annual family income. If you're supporting a big family and an expensive mortgage, aim for the higher figure. With a working spouse and lower housing costs, you may be safe at the lower end of the range.

If I file a claim on my car insurance, will the company raise my rate?

That depends on where you live. In some states, an insurer may eliminate your safe-driving discount. Or a company might raise your rate if the damage passes a certain dollar threshold. Sometimes an accident will be overlooked if you've been with the company for a certain number of years and have a clean record.

Also, the size of any rate increase can vary. Companies usually charge more after accidents that involve drunk driving, expensive claims or multiple claims within three years. Even if you aren't at fault, a company may raise your rate if it decides that you have been involved in too many accidents. Some states, including Massachusetts, New Jersey and Texas, set specific limits on rate increases.

Should you even file a claim? Definitely, if another car is involved, or if someone else was in the car with you when the accident occurred. Your insurance company could hear about the accident later, so get your side of the story on the record. Otherwise, if the cost of repairs is close to your deductible, consider keeping mum and paying the bill yourself (for ways to save on insurance, see The Lowdown on Premiums").

If I file a claim on my homeowners insurance, will the company raise my rate?

It might. But with the insurance industry forecasting that premiums on homeowners insurance will rise an average of 9% this year, it would be hard to tell if your increase was the result of submitting a claim.

However, you stand to give up a 5% to 35% discount you may have earned for having a claim-free history. And more worrisome is the possibility that the insurer will drop you when your policy comes up for annual renewal. A history of repeated claims -- as few as two over the course of two or three years -- could prompt a company to dump you. So think twice before filing a claim that's close to your deductible if you can afford to cover the loss out of your own pocket.

How can I estimate my home's replacement value?

A contractor in your area can give you a general estimate of local construction costs per square foot, which you could multiply by the total area of your home. But the real replacement cost will vary depending on the quality of the materials in your house and any special architectural features.

Insurance companies generally ask a series of detailed questions about your home -– including the square footage, special features and the quality of the materials -– then run the numbers through a database that includes local construction costs for each type of feature. And most high-end insurance companies, like Chubb, will send an appraiser to your house to look at everything and calculate the replacement cost. As a result, it's usually best to work with your insurance company or agent when figuring out your home's replacement value.

It's worth the effort. Several years ago, insurance companies would pay whatever it cost to replace your home if it was destroyed –- even if it ended up costing more than the amount of coverage you had purchased. Now most insurance companies (other than high-end specialists such as Chubb, Fireman's Fund and AIG) cap their payout at 125% of the coverage you've purchased –- no matter how much it costs to rebuild your home. If you haven't kept up with the current costs, you could stuck paying hundreds of thousands of dollars out of your own pocket.

The biggest mistake people tend to make is to base their replacement-cost estimates on the house's market value. The amount of money someone would pay for the house has absolutely nothing to do with the house's replacement value.

Taxes

What are the chances my tax return will be audited?

Slim to none. The IRS ran just one of every 175 individual returns through the audit wringer last year, and even those odds vastly overstate the risk. About two-thirds of the challenges were "correspondence" audits, in which the IRS sends a letter asking for backup information concerning something on the return. The odds are about 600 to 1 against having any face time with an IRS agent.

Those are overall averages; the audit rate varies according to the type of return filed and the amount of income reported. For example, the IRS bragged earlier this year that in 2002 it increased by 22% the number of audits of taxpayers reporting income of $100,000 or more. Still, only about one of every 120 of those returns got "the business," and 40% of those were correspondence audits.

Does filing for an extension raise my chances of being audited?

No. "It's what's on your tax return that matters, not when you file," says an IRS spokesman. The IRS can pull your return for a closer look anytime up to three years after you file, regardless of when that is. Common triggers: home-office deductions, larger-than-average deductions and Schedule C losses.

How can I have the right amount withheld from my paycheck for income taxes?

Update the W-4 form you filed with your employer. If you get a refund every year, increase the number of allowances you claim. If you always owe taxes, reduce the number of allowances and consider having additional money withheld from your paycheck.

Most people claim the same number of allowances as there are people in their household. But don't stop there. You're eligible for extra allowances if you are single and have only one job; if you are married and your spouse isn't employed; or if you have at least $1,500 in child-care or dependent-care expenses and expect to claim a tax credit for those costs (for help in figuring your allowances, try this calculator).

Compute the value of each allowance by multiplying this year's personal exemption -- $3,050 -- by your tax bracket. If you're in the 27% bracket, each allowance you claim will reduce withholding -- and increase your take-home pay -- by $824 a year. If you received a $2,000 refund this year and don't anticipate any big changes in your finances, you can claim an additional two allowances and end up with more money in your paycheck now and a smaller refund next year. If you owed taxes, drop a couple of allowances and you won't have to experience the pain of writing a check to Uncle Sam.

My daughter just graduated from college. Can I still claim her as a dependent on my income-tax return?

Yes, assuming she was in school for at least five months this year -- as most May graduates were -- and you are paying more than half of her support, including food, housing, clothing, education, transportation and medical expenses.

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