Seller Should Pay Off Home Equity Mortgage Before Funding Tax-Deferred Plan

Q I am retired. Six years ago I got a home equity loan to build a rental house. The loan has an outstanding balance of $60,000. I recently inherited two rental houses that I am thinking of selling. My profit would be $70,000. Should I use the profit to pay down that $60,000 home equity loan or invest it in an individual retirement account? I am paying about $1,000 per month on the loan.

--K.B.

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A You didn’t say so, but based on our math, it looks as though you are paying nearly 16% interest on your home equity mortgage. Assuming it’s deductible, that’s an after-tax mortgage rate of at least

10% to 11%. Our experts vote for you paying it off immediately, giving yourself the equivalent return of that amount on your reinvested profit from the sale of the two rentals.

Furthermore, taxpayers at most are allowed to put $2,000 per year into an IRA for themselves. But the law permits IRA contributions only with earned income, and because you’re retired, you may not qualify. Even if you did qualify, our experts note that it would not be wise to use any portion of your $70,000 for an IRA or other tax-deferred contribution until you have completely paid off that home equity mortgage. There’s no sense in making a tax-deferred contribution while continuing to pay such a high interest rate on your borrowings.

Your smartest move is to pay off that mortgage ASAP.

Is a Will Settlement Subject to Taxation? Q I was left out of a will, challenged it and won a settlement. Is this sum taxable? Are my attorney’s fees deductible?

--S.D.

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A The answer depends on the nature of your challenge or, more specifically, the “origin of claim� for your successful “settlement.� Were you deemed to be a legitimate heir who should have been recognized in the will? Or were you presenting a claim against the estate of the deceased for an amount past due? Your answer will determine whether your settlement is taxable and whether your legal fees are deductible.

In general, an inheritance is nontaxable income for the beneficiary. Payments of claims against the state are considered taxable income because they are reimbursement for goods or services rendered. Using this same “origin of claim� distinction, legal fees for nontaxable inheritances are generally not deductible, while those for taxable claims against the estate would be.

Social Security Rules on Ex-Spouse Benefits Q Will you review the rules again for claiming Social Security benefits on an ex-spouse’s account? I am specifically interested in what happens when a person has two ex-spouses. May I decide on which account to make the claim? Does it matter if one ex-spouse is working and the other is already drawing benefits? Also, how much information must I present to make this claim?

--T.R.Q.

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A All right, we can review the rules again, but you must promise to clip this column right now if there is the slightest chance you or anyone you know could use this information in the far-off future, because that is probably the next time it will be answered here.

A divorced spouse (man or woman) is entitled to receive either his or her own benefits or those of the ex-spouse--whichever are higher. A divorced spouse is entitled to receive Social Security benefits accumulated by an ex-spouse if they had been married at least 10 years and the beneficiary is already getting benefits. However, if the beneficiary is still working, the ex-spouse may draw benefits if the couple have been divorced for at least two years and the wage earner is at least age 62.

If your ex-spouse is alive, you may start collecting benefits at 62. However, your monthly benefits will be just 37.5% of the wage earner’s benefits. If you wait until 65 to claim benefits, the payment is 50% of the wage earner’s benefits. If your former spouse is dead, you may start collecting benefits at 60. However, your monthly payments will be just 72.5% of what the wage earner was entitled to receive. The percentage increases until reaching the full 100% if you wait until 65 to begin receiving benefits.

Should you remarry, you are not entitled to claim Social Security benefits as an ex-spouse while you remain remarried.

People who have been divorced more than once, each time for more than 10 years, may claim benefits on the account of the ex-spouse with the largest account. No “double dipping� is allowed. If one marriage has lasted more than 10 years and the other less than that, the divorced person may claim benefits on the account of the spouse from the eligible marriage.

By the way, divorced-spouse benefits are not shared or reduced because a wage earner has more than one ex-spouse. Further, benefits paid to an ex-spouse in no way reduce the amount available for the primary wage earner and his or her current family. These are separate payments, so an ex-spouse in no way robs a current spouse, children or another ex-spouse of anything.

For more information about ex-spouse benefits, order the Social Security Administration’s pamphlet No. 05-10084, titled “Survivor’s Benefits,� by calling (800) 772-1213.

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Carla Lazzareschi cannot answer inquiries individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053 Or send e-mail to [email protected]