It’s hard to imagine functioning in today’s society without access to credit. However, you need to be careful not to fall victim to some of the pitfalls associated with it.

Revolving credit can make it hard for you to pay off debt

Credit cards allow you to spend money you don’t currently have, and to repay what you’ve spent over time instead of all at once. When you use a card, the balance you owe increases, and your remaining available credit decreases. As you make your payments to reduce your outstanding balance, your available credit once again increases. Thus, your credit revolves around for you to use again.

Since you can spend more than you currently have, you can easily spend more than you can afford. As your balance increases, your minimum monthly payments also increase, and soon you’ll find yourself in over your head–especially if interest rates and a variety of fees are high.

Interest and fees can add to the cost

Credit card debt generally carries a high interest rate. Your minimum monthly payment–a percentage (often as low as 2 to 4 percent) of the total balance due–may cover little more than the monthly interest charge. Consequently, your minimum payment may only minimally decrease what you already owe. If possible, increase your monthly payment above the minimum required. The higher you can make the payment, the faster you will pay off the debt.

When opening a new account, always check to see how the finance charge is calculated. Here are some of the methods used:

• Adjusted balance method: Balance due at the beginning of the billing cycle less any payments made during the cycle; excludes new purchases made during the cycle
• Previous balance method: Balance due at the beginning of the billing cycle
• Average daily balance method: Total of the balances due each day in the billing cycle divided by the number of days in the cycle; payments made are subtracted as posted to determine daily balances; new purchases may or may not be added in
• Two-cycle average daily balance method: Same as the average daily balance method, but over two consecutive billing cycles

The amount of your finance charge can vary widely from method to method. Because finance charges result in higher interest charges, creditors favor either of the last two methods mentioned above.

In an effort to attract your business, many lenders offer very low introductory rates–3.9 percent annually or less. However, these rates generally last no more than three to six months and increase to the current market rate thereafter. Moreover, the introductory rates may apply only to balances you transfer from other cards. They may not apply to new purchases and rarely if ever to cash advances. Finally, if your monthly payment is late, the interest rate may be automatically raised to the current market rate–and sometimes beyond.

If you have two different interest rates on one account (e.g., a lower rate for purchases, a higher one for cash advances), the creditor will post the payments toward the lower interest rate balance, not the higher. To avoid this, use two different cards if possible–one for purchases you will pay off when the bill comes (thus incurring no interest charge) and the second, lower-rate card if you have to carry a balance.

You may also incur a wide variety of fees. Creditors may charge you an annual fee to maintain the account. These fees can range from $25 to $50 or more each year. They may also charge fees to transfer balances from other cards. Generally, these processing fees equal 2 to 4 percent of the amount you transfer. Many banks levy a similar surcharge on transactions involving conversions from foreign currencies. If you’re late with your monthly payment, you may be charged a late payment fee that can be as much as $39 each month you’re overdue. If your account balance rises above your approved credit limit, you will be assessed a monthly overlimit fee until you bring the total balance due under the limit you’re allowed.

When these fees add up, you may find that making your minimum monthly payment won’t bring your balances down. In fact, your balance will increase if your monthly payment isn’t greater than the accumulated interest and fees due, since these unpaid charges become a part of the principal you owe. Moreover, your account may then be considered past due and reported as such to the credit bureaus.

If you surf your debt, beware the wake

You may periodically transfer your balance from one introductory offer to the next. This is known as surfing. Done successfully, surfing lets you avoid the higher interest charges that your debt would incur when the original card offer expires. By the time the interest rate on the original card increases, you’ve surfed over to a new offer at another low rate.

Although surfing helps keep your interest charges to a minimum, it’s not without pitfalls. You may be offered a low rate only on balance transfers; if new purchases and cash advances are billed at a higher interest rate, these charges could offset the savings you would otherwise enjoy. Moreover, as creditors move to counteract the surfing trend, many stipulate that if you transfer balances to another card within a certain time after opening your account, you’ll be retroactively charged a higher rate of interest on the amount you transfer. Thus, surfing before this time period is up eliminates the savings.

Finally, if you transfer balances to a new card, close the original account as soon as you’ve paid it off. Write the creditor a letter (keep a copy for your records) asking it to inform the credit bureaus that the account was closed at your request. This prevents new potential creditors from denying you credit when they see too many open lines of credit, and it also deters anyone else from fraudulently using an inactive account.

Protect yourself against credit fraud and identity theft

Credit fraud (the illegal use of your accounts) and identity theft (opening new credit using information about you) are two of the fastest-growing crimes today. In many cases, you may not know you’ve been victimized until it’s too late. Here are some indicators of these crimes:

• A creditor informs you that it received an application in your name
• You’ve been approved for or denied credit you didn’t apply for
• You no longer get your credit card statements in the mail
• Your credit card statements include purchases or cash advances you never made

To minimize the chances of being victimized, take precautions to safeguard your credit account information. Don’t carry credit cards you don’t use often. Be sure to sign your cards, and never sign a blank charge slip. When you use the card, try to keep it within your sight. Save your receipts, and obtain and destroy any carbons. Don’t allow a sales clerk to write your credit card number on a check “for identification.” Finally, never give out your account number over the telephone unless you initiated the call and know the organization to be reputable.

April 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP , a local member of FPA.

It’s a few short weeks until cap and gown season begins, and for grandparents hoping to do something nice for their grandkids and something sensible for their estate, there are several options to explore.

Roth IRAs: The Roth option is a good one if you want to help them start a retirement fund of their own or if you want them to inherit a Roth where they can make tax-free withdrawals after your death.

Roth IRAs aren’t a useful alternative for very young kids because the rules state that all Roth holders have to have earned income to be able to make contributions. If they fit that description – as many kids working in high school do – either their parents or guardians can open the account and grandparents can make contributions to match the percentage of earnings kids put in their Roth IRA. Grandparents simply match that contribution.

Also, if you have a Roth IRA, you can benefit your grandchildren by naming them as your primary beneficiaries, and when they inherit it, they’ll be able to make tax-free withdrawals for a home, an education or any other purpose.

Parents or grandparents may want to consider setting up and funding a Roth IRA for their children or grandchildren as soon as the children or grandchildren have enough earned income from part-time or summer jobs. This will ensure that the five-year requirement is met when the individual for whom the Roth IRA is established is ready to make a withdrawal to buy a home, for example.

529 Plans: Another great tool for grandparents is the 529 college savings plan. Grandparents can fill out a plan enrollment form designating a grandchild as beneficiary, select the investments from the plan’s options, and make future contributions either by check or by automatic contribution.  It’s also fine for grandparents to make their contributions directly to a 529 account already owned by the grandchild’s parents.

As a refresher, 529 college savings plans – named for the federal law that created them in 1996 – allows a parent to open a tax-deferred college savings plan with as little as $25 to start in some states.  A 529 college savings plan is not the same thing as a 529 prepaid college tuition plan. Prepaid tuition plans are just that – tax-deferred savings plans that allow you to save for tuition for in-state schools (though some plans allow you to transfer out a portion of those assets to out-of-state schools). Also, it’s important to note that prepaid tuition plans are not an automatic guarantee a student will get into that college.

Since 2006, withdrawals from 529 plans have been permanently tax-free. In some states, contributions may also be deductible on state tax returns. All 50 states now have 529 plans college savings plans, and a majority of them provides additional incentives, such as a state-tax deduction to in-state residents who invest in their respective plan.

It’s a good idea to have your financial adviser or your CERTIFIED FINANCIAL PLANNER (TM) professional help you sort through the details of various state plans. There are various services – including Morningstar Inc. – that now rank the offerings of each state’s plan.  www.SavingforCollege.com and www.FinAid.org are leading sites to help educate you in how these plans work.

Grandparents can treat their contribution as complete gifts, which means they can apply the $12,000 per year gift tax annual exclusion or an accelerated contribution of up to $60,000, with a special five-year, gift-spreading election. Check with your tax adviser first.

Another great benefit is that a 529 plan owned by grandparents should not affect the grandchild’s eligibility to receive federal financial aid because a grandparent’s assets are not reportable on the free application for federal student aid, or FAFSA, and the tax-free withdrawals from a grandparent-owned 529 plan are not counted as student income or student resources.

Coverdell Education Savings Accounts: For grandchildren heading to private school who are under the age of 18, most grandparents – check your eligibility with a tax professional first – can contribute up to 2,000 dollars annually per grandchild to a Coverdale Educational Savings Account.  Coverdell earnings accumulate free of federal income taxes, and can be taken to pay for private elementary, secondary or college. Yet, your income is a factor. You can make a Coverdell contribution as long as your modified adjusted gross income is between 95,000 and 110,000 dollars if you’re single or between 190,000 and 220,000 dollars if you’re a married and filing jointly.  Yet, if you exceed either of these requirements, you can ask the parent of the adult child to open up the account and make the contribution, though you will have to give up control over the account.

Make a direct gift of your grandchild’s tuition: Under current tax law, you can make gifts of any amount to cover your grandchild’s tuition. Yet, you’re going to need to pay the college directly and you need to be aware that it won’t dent your federal estate tax exemption (3.5 million dollars in 2009), but it will cut the overall amount of your taxable estate.  You can, however, go ahead and make additional gifts per grandchild of $13,000 to help with other college expenses.

April 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP , a local member of FPA.