Financial Q&A: Retirement-plan rules on borrowing for a home

Q:

I would like to look at ways to invest my income in order to accomplish two goals: Buy my first home and save for retirement. Since there are ways to save on income taxes in 401(k) and IRA programs, I am wondering if there is a way to put money into an IRA or 401(k) and pull money from it for a down payment on a first home without incurring significant tax penalties?

R.L., via e-mail

A: When saving for retirement, a 401(k) or an IRA is definitely the best way to go, says Mike Bowen, vice president at WealthTrust Arizona in Scottsdale. You may be able to contribute to both a 401(k) and an IRA if your income qualifies you to do that. You want to make sure you are within the income limits to claim the IRA contribution as a deduction and are within the contribution limits of both.

If your employer offers a match on your contributions to your 401(k), it's a great way to save for retirement due to the extra money from the company. But Mr. Bowen says a 401(k) does not allow for penalty-free distributions for the purchase of a first home. There is a 10 percent penalty on early distributions (before the age of 59-½).

An IRA has an exception for this penalty when the distribution is used for the purchase of a first home. But the amount that is exempt from the penalty is limited to $10,000.

Q:

Changes in the estate tax implemented in 2001 will expire in 2010. We did some planning under the old law and implemented changes only to see the exemption change make our planning moot. In the interim, savings and investing have increased our estate again, making it even more likely to have a problem in 2011. How can families plan for the future under uncertainty?

T.S., via e-mail

A: You'll have to be willing to accept change, and you'll have to be dynamic. Those are two quick points on this topic that spring to the mind of financial adviser Paul Baumbach, of Mallard Advisors LLC in Newark, Del.

By dynamic, he means that your estate-planning documents should avoid setting dollar amounts, and referring to "Unified Credit" and similar language that change with the law. Further, he says that language in the documents should include the right to disclaim, so a beneficiary, after your death, can strategically elect to refuse some of an inheritance (if this saves on estate taxes).

While the estate tax law will change prior to 2011, Mr. Baumbach doesn't see any changes occurring until January 2009 at the earliest. "There is zero incentive for Congressional Democrats to compromise now when in January 2009, they will at least have more votes, if not a Democratic White House, and so they will be in a better position to craft a solution more to their liking," he says.

In the meantime, you, or your planner or attorney or both, should double-check now to see that everyone is prepared to review your documents after estate tax changes have been defined for 2011 and beyond.