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Canceled Debt Doesn't Vanish--It Becomes Black Mark in Credit File

May 21, 2000|LIZ PULLIAM WESTON

Q: I'm trying to help a friend who was recently turned down for a loan from a local bank. When we got her credit report from Experian, it showed an unpaid balance of $2,600 on one of her credit cards. She showed me a 1099C tax form, issued by the credit card company in 1995, showing that the entire amount had been canceled. Why is it still showing up on her credit report? This gross error cost her a much-needed loan. We've asked the credit bureau to investigate, but the telephone representative said it would take 30 days.

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A: You're wasting Experian's time, as well as your own. A canceled debt does not disappear from your credit report; in fact, it stays as one of the blackest marks you can get, short of bankruptcy.

The credit card company issued the 1099C because it had given up on ever collecting the money from your friend. By sharing the information with the credit bureau, it was warning other companies that she's not a good risk because she doesn't repay her debts. In other words, the gross error was made by your friend, not the credit bureau.

Of course, the impact of her misdeed will fade over time, especially if she has paid her bills promptly since then. If the debt remains on her credit report after 2001, she would have legitimate cause to ask Experian to expunge the canceled debt from her record. Most negative information must be removed after seven years (or 10 years in the case of a bankruptcy).

Your friend may or may not have another problem. The Internal Revenue Service usually considers canceled debts to be taxable income to the debtor, which means your friend probably should have paid income tax on the forgiven amount in 1995.

Given that more than three years has passed, the IRS is unlikely to come after her now, but the agency is getting better about matching 1099 forms to taxpayer returns to figure out who should be paying what. Should she ever face this situation in the future, both her credit report and her pocketbook could suffer.

Fan of Variable Life Policies Q: Your answer to the lawyer who was considering a variable life policy failed to mention one of the most attractive features of the insurance. You may pull money out of a policy completely tax-free through a series of loans and withdrawals. As a father with two young children, the reader definitely has a life insurance need. Based on my analyses as an insurance agent, variable life is the most cost-effective way of providing that insurance, as well as providing a supplemental retirement plan (buying term and investing the difference is a poor substitute).

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A: Actually, the reader in question already had $2 million of term life insurance. His agent was trying to sell him more insurance in the form of a variable policy, making the same arguments you did about the tax-free features. It wasn't clear whether the agent was advocating the policy in addition to or in lieu of an employer-funded plan.

What both you and the other agent failed to mention is that withdrawals and loans, if not paid back, ultimately reduce the value of your policy. Loans especially can silently rack up huge interest costs over the years. The result is less money for your survivors. Presumably, protecting your survivors is why you would buy insurance in the first place.

As to whether variable life can substitute for a real retirement plan, read the following from one of your colleagues.

The Other Side of the Coin Q: I am an insurance agent and just wanted to tell you your advice to the attorney was correct and I hope the person took it. If his insurance agent was suggesting a variable life policy in lieu of a tax-qualified plan, the agent ought to be shot. Never would I suggest to a client that a life policy is superior to any tax preference-qualified plan. I tell clients that a life policy is the very last place to do one's investing. If, and only if, the client has funded every other available retirement account, still has money to put away and needs life insurance on a permanent basis, then I might think a variable life policy was an option. But I see that in 1% or less of our clientele. Life insurance should be purchased for what it is intended, to benefit someone if you die. Selling based on end-use greed is how most of us agents were taught, but I separated from that philosophy almost 20 years ago.

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A: Your clients are fortunate indeed. Insurance agents tend to earn hefty commissions on variable life policies, which gives them a powerful incentive to recommend the coverage even when it might not be the best fit for the client. A knowledgeable agent who truly puts his clients' needs first, as you appear to be doing, is a true gem--and rather difficult to find.

That's why I recommended that the lawyer consult with a fee-only planner who specializes in workplace retirement plans. The planner could help him set up a plan at work while evaluating his insurance needs and seeing if a variable policy was a good option.

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 liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times' Web site at http://www.latimes .com/moneytalk.

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