What to know about buying a house using retirement funds
Dear Liz: My husband and I are thinking of purchasing a house near us. Can we use any funds from our retirement accounts to make the purchase? We would like to use this money along with some savings so that we do not have to carry a mortgage.
Answer: You don’t mention how old you are, whether you’re currently homeowners or what type of retirement accounts you have, which are all important factors.
If you’re under 59½, withdrawals from IRAs and workplace plans such as 401(k)s are typically taxed and penalized. You can avoid the penalty, but not the taxes, if you’re considered a “first-time home buyer” and you withdraw up to $10,000 from your IRA to buy a home. (“First-time home buyer” just means you and your spouse haven’t owned a home within the last two years.)
This exception doesn’t apply to workplace plans such as 401(k)s. However, if you’re still working for the employer who provides the plan, you could consider taking a loan from your account.
Loans typically must be repaid within five years, but your employer may offer a longer payback period for the purchase of a primary residence. If the employer permits plan loans, the loan limit is typically the lesser of $50,000 or half the vested account balance, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.
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An exception to the 50% cap is if 50% of your vested account balance is less than $10,000, Luscombe said. In that case, you can borrow up to the lesser of $10,000 or the balance in your account.
If you have a Roth IRA or Roth 401(k), the amount you contributed can be withdrawn for any purpose without taxes or penalties, Luscombe said.
Tax issues and trusts
Dear Liz: You recently responded to a reader’s question about protecting an intended bequest. In the answer you wrote, “Assets in the trust get a step-up in tax basis when the first spouse dies, but not when the surviving spouse dies.” My understanding is that, in California and other states with community property laws, the basis of eligible inherited community property gets stepped up twice: once for the surviving spouse and then again for the person who becomes the final beneficiary of the asset. I thought that using a revocable trust does not affect this “double step-up.” A married couple whose principal estate asset at death is their jointly owned (and substantially appreciated) home may never explore the benefits of a trust if they believe that one-half of the anticipated step-up in basis will be lost. Might you clarify what the sentence in your column means?
Answer: The double step-up works somewhat differently from what you’re describing, and the trust in question is quite different.
A step-up in basis happens when someone dies and an inherited asset gets a new value for tax purposes. The asset is “stepped up” to the current market value, which means any appreciation that happened during the deceased owner’s lifetime is never taxed. (Basis also can be stepped down for assets that have declined in value.)
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In most states, when one spouse dies, only half of a couple’s jointly owned assets gets a favorable step-up in tax basis to the current market value. The surviving spouse’s half doesn’t get a step up in value until he or she dies.
In community property states, however, both halves of the couple’s community property get the step up with the first death, said Los Angeles estate planning attorney Burton Mitchell. That’s what is known as the double step-up in basis. If the survivor dies owning the property, it gets yet another step-up in tax basis.
Now let’s move on to trusts. The double step-up in basis is not affected if you own property in a kind of revocable trust known as a living trust. Living trusts are designed to avoid the court process known as probate, and they can be changed during the creator’s lifetime (hence the term “revocable”).
The trust in question, however, was a bypass trust. The original letter writer asked how to make sure her son from her first marriage would receive an inheritance if she died before her current husband.
One of the options would be to create a bypass trust that gave the spouse income from her assets during his lifetime, with the assets transferring to the son at the spouse’s death. Such trusts can help ensure the assets actually get to the son someday and aren’t spent by the surviving spouse, or the surviving spouse’s next spouse. Among the disadvantages is the fact that assets placed in the bypass trust don’t get a step-up in tax basis when the surviving spouse dies.
Another type of trust to consider in this situation would be a qualified terminable interest property (QTIP) trust. Unlike the assets in a bypass trust, assets in a QTIP would be included in the deceased spouse’s estate, which means they would get a step up in basis when the survivor dies.
Clearly, this is a complex topic, so you’d be wise to get an experienced estate planning attorney’s advice.
Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.
