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Letters: How can my kid build credit history the responsible way?

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Joining guest host Tony Cox to offer advice and help sort out your personal finance challenges this week is Liz Weston, an advice columnist and author of several books, including "The 10 Commandments of Money: How to Survive and Thrive in the New Economy."

John from Anoka, Minn., wonders what it will take for his daughter to build a credit rating. His daughter graduated college last May. She made it through college with no debt and now has a full-time job. She currently lives at home and has about $16,000 in the bank. She would like to buy a house, a fixer-upper. But she has no credit rating and couldn't get pre-qualified for a home loan. She did get a credit card, which she puts gas and some meals on, and then pays off each month. What else is available to help build her credit?

"This is actually a fairly common problem of people who avoid debt wind up having no credit score or no credit score to speak of. Credit scores are really important in today's life. It doesn't mean you have to go into debt to have a good one," says Weston. "The way she is using that credit card is absolutely the right way to go. Charge a little bit on it. Make no more than 30 percent or so of the credit limit. Pay it off in full every month. You do not to carry debt to have good credit scores."

Weston says to speed things along, John might consider adding his daughter as an authorized user to one of his credit cards. She says John should talk to his credit card company to make sure that his information for his card will be exported to his daughter's credit file because that doesn't always happen. Other ways to jump-start her credit? Get a second credit card (having a couple in the mix can really help) or consider getting a small installment loan. Weston says she should track her FICO score at myFICO.com because that's the one most lenders look at.

Amy from Bakersfield, Calif., wonders if there are any downsides to paying off student loans quickly. Her and her husband have student loans totaling $107,000 and most are at 6.8 percent. Their plan right now is to put as much money towards paying these loans off as possible and live on the bare minimum. Based on income, she says they could probably pay off the loans in about two years. But should they be saving for retirement instead?

Weston advises her to save for retirement.

"I would say you are a great time in your life to get started with saving for retirement. You do not want to pass up those opportunities," says Weston. "The longer you put it off the harder it is to catch up. So I would say don't be in such a rush to pay off those loans. Take a look at what your retirement savings opportunities are. Make sure you have adequate insurance -- that's really important. Health insurance, maybe life or disability insurance. Make sure you have an emergency fund, then start pounding away at that student loan debt. Make sure all your ducks are in a row before you go after this relatively low rate tax-deductible debt."

Listen to the audio player above to hear advice on whether it's worth it to be debt free and her thoughts on annuities.

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Liz Weston mention two types of annuities - fixed & variable. She should have also informed the listener that, like mutual funds, there are load & no-load annuities. Companies like Vanguard and TIAA-Creff sell no-load, no-surrender-fee, low-expense annuities. An insurance agent who needs to make a commission will likely be selling a load annuity with a surrender fee that may last 7 years or longer, and usually has a higher annual expense ratio than one from a no-load mutual fund company. Caveat emptor - educate yourself and shop around.

Liz, you told one caller to not rush to pay off their student loans because "the interests is tax deductible" then go on to tell another caller that "interest tax deduction is like paying a $1 to get $0.25" on a home loan. So which is it?

I would have urged them to pay off their debt. Get out from under it. You would be better off not paying interest on loans because you get zero value from what you pay in interest. That is money you won't be able to invest, or save, or spend on quality items.

The question about the lump sum pension payment included a statement that "the lump sum is about $100,000 less than the present value of his future pension payments." I doubt this is true. The caller should get some advice from a qualified pension actuary to compare these amounts.

DR,
True, the present value calculation is complex, as it involves mortality and interest rates. Regardless of the accuracy of the statement, it is hard to believe a pension plan , with its access to actuaries, would offer more than present value. After all, they are the ones trying to get out from under the pension payouts. On the broadcast, it seems likely the low offer was sweetened by the irrelevant (IMHO) enticement of being inheritable.

Another factor not discussed was taxes. Unless this lump sum was rolled into another tax-deferred vehicle, there could be some hefty taxes to be paid. The caller probably should have been warned about this as well.

Regarding the caller whose father was offered a lump sum settlement in place of his pension, I was surprised at some of the things Liz did not talk about.

1) It was not emphasized that the first priority is to be sure her father has enough to live on - Inheritability is a distant second consideration.

2) No skepticism was expressed that the father could come out ahead financially. What is the likelihood that a lump sum worth $100,000 less than the present value of the annuity he is already receiving, will be sufficient to buy an annuity of equal or greater payout, combined with survivor benefits, AND pay the fees incurred in buying the new annuity? I would say about zero, especially, as was mentioned, with interest rates on fixed annuities so low.

3) How secure would the new annuity be? His current pension is guaranteed, to a certain dollar amount, by the Pension Benefit Guaranty Corporation. An insurance company annuity is only as secure as the issuing company.

4) Given items 2 and 3, what is the benefit of converting a federally guaranteed pension to a smaller, less secure, annuity?

5) The whole proposition makes sense only if, sadly, the caller's father has a serious, life shortening, illness that makes it unlikely that her father would outlive his lump sum, and would therefore leave an inheritance behind.

If her father does not need his whole pension for his living expenses, his best plan to provide an inheritance for his grandkids, is to save his unused pension and live a long, healthy life, and watch those grandkids grow; when the inevitable happens, they will receive an inheritance of both love and money.

Liz,

In response to at least two of the calls this week, you suggested that student loan debt is "good debt" because it is tax-deductible. At the risk of picking nits, I thought it was important to point out that (a) only the interest on these loans may be deductible, and (b) for higher income earners, only some portion of this student loan interest, or perhaps none of it, may be deductible.

The details are widely available (including here: http://taxes.about.com/od/deductionscredits/qt/studentloanint.htm), but people should keep in mind that the maximum student loan interest deduction (for 2012) is currently $2,500/year, and this only applies to individual filers earning less than $60K or married couples earning less than $120K. If your income is at least $75K as an individual or $150K as a married couple, you cannot deduct any portion of your student loan interest.

When the difference in interest rates between private and government-backed student loans is as high as it currently is (e.g., approximately 2% vs. 6-8%), I tend to be less enamored of this so-called "good debt" than you. The caller who was prepared to pay off $100K in student loans in 2 years seems to be on the right track. While I agree that it is important to begin saving for retirement early, with these kinds of loans I would advise her to focus her energies on paying these off as she must be paying more than $5K/year in interest alone (at a rate that is likely higher than she'd realize on a 401K).

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