Dads Don’t Count With Credit Bureaus

Q: My daughter just graduated from college as a chemical engineer and has started working for an oil company at a very good salary ($54,000). She is buying a new car but, because she has a limited credit history, the two lenders we consulted added three percentage points to their normal car loan rate. That’s even with me, her father, as a loan co-signer. It makes more sense for me to lend her the money at a standard rate, because I’ll make a couple of percentage points above the rate I get from my money market funds. But how do we build her credit history if she borrows from me and pays back over time?

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A: The short answer: You can’t.

Credit bureaus collect information from commercial lenders--banks, credit card issuers, car lenders, etc.--not from generous dads. The way credit bureaus are set up, there is no way for such a personal loan to be included in your daughter’s credit history, said Maxine Sweet, spokeswoman for Experian, one of the big three credit bureaus.

That doesn’t necessarily mean you shouldn’t go ahead with the deal. Your daughter can build a credit history in other ways, such as by applying for and carefully using a credit card. Sweet recommends buying a piece of furniture and paying it off over time as one way of adding to a credit history.

You might also talk to your daughter about the wisdom of buying a less expensive used car now and waiting a few years to buy a new one. By then, she’ll probably have a good enough credit history to get a loan on her own and she’ll have saved a couple of thousand dollars in the meantime, because she won’t be paying for the depreciation on a new car.

A 401(k) Caution

Q: I recently lost my job. With the stock market the way it has been lately, I have been thinking about transferring my retirement funds out of my 401(k) into some sort of IRA, then withdrawing the money to pay off my home mortgage. I have already moved my 401(k) funds to a very low-risk option, but it’s still taking a beating. What would you advise?

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A: It’s pretty common for one bad idea to breed another, but you’ve got a kennel-full here.

You can certainly roll your 401(k) money into an individual retirement account if you like. But it’s silly to then take the money out, because you would end up paying about half of whatever you withdraw to the government in taxes and penalties.

Using the money to pay off a home mortgage goes a step beyond silliness. You need maximum financial flexibility right now, and paying off your mortgage would tie up more of your money in your house--giving you much less flexibility than you have now. Paying off a low-interest, tax-deductible mortgage is not a good idea for most people, but particularly not for someone who is unemployed.

You also should reconsider moving all of your money to low-risk options. If you ever want to retire, you’re probably going to need the long-term growth that stocks can offer. It makes sense to become somewhat more conservative with your retirement funds when you’re laid off--if worse comes to worst, you may need to tap those funds despite the penalties, and having a portion in safer cash and bond options can ensure that you’ll have the money when you need it. But few investors should have all their money in cash and bonds.

Hardship Distribution

Q: In a recent column, a husband had withdrawn money from his 401(k) to pay his wife’s debt--which turned out to be unnecessary. You advised that the money could be rolled over into an individual retirement account if done so within 60 days of the withdrawal. I work for a tax preparation chain, and it’s my understanding that if the husband got the money through a “hardship distribution,� the money would not be eligible for rollover, because the IRS has banned such rollovers if the distribution was made after Jan. 1, 2000.

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A: As always in tax matters, the devil is in the details.

There are several ways to get money out of a 401(k) plan, depending on your age and circumstances. Some plans allow for “hardship distribution� under strictly defined circumstances, but these withdrawals are tough to get and generally require you to prove that you’ve exhausted all other financial possibilities.

If, in fact, the husband did get the money under the plan’s rules for a hardship distribution, his ability to roll the money over into an IRA might be restricted, said Glen Sulzer, an analyst who specializes in 401(k)s at tax research firm CCH Inc.

If the hardship distribution came from his elective contributions--in other words, if the plan paid out money the husband had paid in from his paycheck contributions--then the money couldn’t be rolled over into an IRA, Sulzer said. This rule was made to prevent taxpayers from avoiding penalties and taxes on early distributions, Sulzer said.

But the tax code doesn’t prevent a rollover if the money came from the 401(k) account’s earnings, employer-matching contributions or profit-sharing contributions, Sulzer said.

These complexities just underscore why it’s so important to get a tax professional’s advice before touching money in a retirement plan.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at [email protected] or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.