Financial Q&A: Readers' money questions answered

Paying off an old debt may salve your conscience, but not your credit; some advice on IRAs.

 Q: My daughter got a credit card while in college, ran it up, and then failed to pay. The bank wrote it off and sold the debt. She has now received an offer to settle the bill for much less from a company that is not the original creditor. A letter says it will alert the credit bureaus of the agreement and consider the debt settled. Should she repay this debt this way?

S.K.W., via e-mail

A: It won't do a huge amount of good to repay a charged-off account unless it's done at the time it's charged off, according to Bryan Beatty, a certified financial planner in Vienna, Va.

His reasoning is that once the account is written off, the reporting activity stops, and a clock begins to tick, and your score will begin to improve (slowly, but it does). If you were to then negotiate to pay it off after that charge off, that money-due clock will start ticking all over again.

By resurrecting a charged-off debt, you may relieve any guilt of having walked away from an account. But you have reopened a wound on your credit report, Mr. Beatty says, and it takes seven years for old information to disappear from a credit report.

 Q: What are the differences between a traditional IRA and a Roth IRA?

P.C., via e-mail

 A: Greg Fernandez, a certified financial planner in McLean, Va., explains the differences this way:

• A traditional IRA is a personal savings plan that offers tax benefits to encourage retirement savings. You can contribute up to $5,000 for tax year 2008 (and you may be able to contribute up to $5,000 on behalf of your spouse, if you're married). The annual amounts are indexed for inflation thereafter. If you're age 50 or older, you can contribute even more: $6,000 for 2008. Contributions are either deductible or nondeductible, depending on your income and whether you participate in an employer-sponsored retirement plan, such as a 401(k). Regardless of whether your contributions are deductible, earnings in a traditional IRA grow tax-deferred.

• A Roth IRA is another type of personal savings plan. Its contribution limits are similar to those of a traditional IRA, and the investment options are similar, too (stocks, bonds, mutual funds, etc.). But unlike a traditional IRA, all contributions to a Roth IRA are nondeductible from your income taxes. So you don't get a tax break by going into a Roth. But you do on the way out, because if certain conditions are met, withdrawals from a Roth – including any earnings – are tax-free.

 Q: Can income from Social Security, a 401(k), or an IRA be used to invest in an IRA or a Roth? Can mortgage interest be deducted against this income? Lastly, what is the difference between income and taxable wages?

B.F., via e-mail

 A: You can only use earned income to fund a retirement plan, be it an IRA, 401(k), 403(b), or whatever. Think of it this way, says Gene Utterback, a tax expert and registered financial consultant in Annapolis, Md.: In order to put money away for retirement and get a tax deduction for it, you first have to pay Social Security and Medicare taxes on the money.

Here's another hurdle. If you are over 70-1/2 years of age you cannot make a tax-deductible contribution to a traditional IRA. It doesn't matter how much you have in earned income.

As to mortgage interest, it's deductible if you itemize your deduction on federal Schedule A. If you don't itemize – or if your itemized deductions are less than the standard deduction – then you get no benefit.

Now, about the difference between income and taxable wages, Mr. Utterback says that income includes all money received, and the legal assumption is that it is all taxable unless specifically exempted from tax. Taxable wages are what you receive in exchange for the job you do at work – this is earned income.

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