Love the Guy, Hate His Credit Record? Spouses Needn’t Merge Their Financial Lives

Q My fiance and I will be marrying soon. Our problem is that he has accumulated a terrible credit record. Is it possible that my unblemished credit record could be affected by his bad one?

--A.L.

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A The unfortunate answer is yes. However, you do not have to commingle your credit lives. This is true even in community property states such as California.

In theory, it’s possible that someone with a bad credit history could improve his or hers by marrying someone whose record is impeccable. But in most cases, the opposite occurs.

Experts recommend a simple strategy: Before they wed, a couple should sign an agreement pledging to keep their financial assets--including property, credit cards and any debts incurred by each--separate property.

In addition to signing this statement (it’s actually a type of prenuptial agreement), the two must be careful to notify any new creditors of the agreement after the wedding. This is especially important in community property states.

For example, in California, if a married person gets a new credit card, the debts accumulated on the card are presumed to be the obligation of both spouses, even if only one of them is listed on the card.

The only way to avoid this kind of assumption of financial obligation is to notify the card issuer of your separate property arrangement at the time you apply for the card. The fine print on the application should explain the process. If you can’t find that on the form, submit a letter with your credit application that explains your arrangement.

At any time during a marriage, spouses in community property states may establish themselves as separate financial entities, but they may opt out of community property debts only in advance of incurring them. Obligations incurred before the financial separation remain the equal obligation of both spouses regardless of who incurred them.

Couples adopting this strategy should promptly notify their creditors of their decision.

You will probably be required to apply for new credit cards as individuals and face an individual evaluation of your credit-worthiness based on your earnings and marital credit history.

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Q In withdrawing from an IRA, is the whole withdrawal subject to taxation or just the portion of it consisting of money contributed on a pretax basis?

--T.P.F.

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A The portion of your IRA withdrawal that has not been subject to taxation is taxable upon disbursement. That said, you should also know that taxpayers whose individual retirement accounts consist of both pretax and after-tax contributions face a withdrawal process more complicated than just knowing that withdrawals of pretax contributions are subject to taxes.

All withdrawals must include the pretax funds and after-tax funds in the same ratio they are represented in all your IRAs. Then you pay tax only on the pretax amount withdrawn.

The first step is to determine how much of your IRA accounts are from pretax contributions and how much are from after-tax money. Keep in mind that you must combine the totals from all of your IRA accounts if you have more than one. Then you must determine what percentage of your total IRA holdings these pretax and after-tax contributions represent. Remember that any interest, capital gain or dividends from the after-tax contribution have not been taxed and are thus considered part of the “pretax” portion of the accounts.

This ratio is the one you must assign to your withdrawal(s) for that year, and the ratio must be recalculated each year.

The ratio of your after-tax holdings to the IRA total balance is the percentage of your withdrawal on which you are not subject to either taxation or penalty upon withdrawal.

For example, if your IRAs have a current value of $200,000, and $50,000 of that amount was contributed on an after-tax basis, then one-quarter of your withdrawal would be free from taxes (and from penalties, if they would otherwise apply). However, unless you are disabled or take annuity-like disbursements, the remainder of your withdrawal will be subject to taxation and also, if you make it before the year you turn age 59 1/2, a 10% federal and a 2.5% California penalty.

For more information about IRA withdrawals and related issues, order IRS Publication 590, Individual Retirement Arrangements, by calling (800) 829-3676. The material can also be downloaded from the IRS Web page on the Internet. The address is https://www.irs.ustreas.gov

Carla Lazzareschi cannot answer mail 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 carla.lazzareschi@latimes.com