Dorothy in Taxland: Tax Credits (2010-06-21)

Dorothy in Taxland: Tax Credits

(2010-06-21) by David John Marotta

Tax credits are much more valuable than tax deductions. Deductions only reduce the amount you are taxed on. One dollar of deduction might only be worth 35 cents. In contrast, tax credits are a dollar-for-dollar reduction in your tax bill. And a refundable tax credit could mean the government will owe you money you never paid in the first place.

The final tax formula is "Total tax minus payments equals the amount you owe or have overpaid." The critical part of this formula is that payments include not only the money you have given the government but also any tax credits you are eligible to receive.

But most people fail to claim all their legal tax credits and miss opportunities to gain some real wealth redistribution.

For example, if college students have earned income, they can receive the Making Work Pay tax credit. It's a refundable tax credit worth 6.2% of earned income with a maximum of $400 per person. This credit is phased out for middle-income families but not for their children. They are eligible as long as their parents don't claim them as dependents.

Even if these students pay no tax, they will still receive a check from the IRS for $400. That's the beauty of a refundable tax credit. Students who file a tax return can take advantage of several other tax credits.

As a parent of a college student, you could receive a Hope tax credit. Usually this is a $1,800 credit for the first $2,400 spent on a college education during the first two years. But for the past two years it has been enhanced for students in the Midwestern disaster area to be $3,600 on the first $4,800 spent. If you have saved in a College 529 plan, you cannot receive this credit for money disbursed from the 529.

But if you spend $24,800 on the University of Chicago, for example, you can reimburse yourself $20,000 from the 529 and still receive the full $3,600 Hope tax credit for having spent $4,800 out of pocket. Spending $1,200 outside the 529 allows you to keep an extra $3,600 inside the plan.

Alternatively you can get the American Opportunity credit, which gives you up to $2,500 on the first $4,000 of educational expenses. It isn't limited to the first two years of college and is partially refundable. You can also take advantage of the Lifetime Learning credit and get $2,000 on the first $10,000 spent. Even part-time students who only took a single class are eligible.

This year many adult children of millionaires will receive an $8,000 First-Time Home Buyer tax credit. Many wealthy families will receive a $6,500 Move-Up/Repeat Home Buyer tax credit. These credits were available for couples with incomes under $225,000 who purchased homes priced at $800,000 or less. It's good to know we are using our tax credits to support the truly needy.

In many very rich families, everyone got a new home this year. Money is being given to each child to help him or her buy a home and make payments. In three years all the homes can be sold for a profit. In the meantime everyone gets an $8,000 refundable tax credit.

If you install a new air conditioner, windows, doors, roofing, furnace or water heater, you can also qualify for tax credits. The replacements have to be more energy efficient. Nearly everything new qualifies. Even those with enough discretionary income to make improvements without any governmental incentives can get a $1,500 tax credit.

According to the IRS regulations, nearly every window sold today will qualify as more energy efficient than the older windows being replaced. But the window companies have lobbied for taxpayers who can't afford to replace their windows to subsidize wealthier individuals who can. Nearly anything can be justified these days by calling it green.

The geothermal heat pump manufacturers must have had an especially adept lobbyist. Their merchandise isn't subject to the $1,500 cap and is worth 30% of the cost. So are solar energy systems or small wind energy systems.

There's even a tax credit for contributing to your retirement account. Couples earning less than $50,000 can get a tax credit up to $2,000. They can get a tax deduction for the contribution and still receive the credit. Even students can qualify if they are part time and not claimed as a dependent.

Probably the largest of all is the Earned Income tax credit. It is intended as the primary way to help the working poor, defined as a family of four with an income less than $45,295. The maximum credit is $5,028 with two children.

If you choose to take your children as dependents, you may also qualify for the child tax credit. It provides a $1,000 tax credit for each child as long as couples earn less than $110,000.

Finally, there is still a federal energy tax credit if you buy a hybrid electric vehicle. Incredibly, the IRS has ruled that even golf carts qualify under the rules of the $700 billion bank bailout. Every golf cart manufacturer has applied to become a licensed motor vehicle dealer and modified its carts to be street legal and plug into the wall. Getting a $5,900 tax credit on buying a golf cart can't possibly be what legislators intended.

Most of these tax credits are just a percentage of what you have to spend to qualify. Because the poor don't have much discretionary income, these tax credits do not help them at all. Mostly they subsidize the upper middle class and the businesses in specific industries who have lobbied to qualify.

I've personally taken advantage of nearly every tax credit available. In fact, this year each of my children got refundable credits giving them thousands of dollars more than they actually paid. Tax planning and management is increasingly a crucial part of wealth management. But it is terrible public policy. I think it is every citizen's civic duty to vote against the hands that try to bribe special interest groups with tax credits.

Hundreds of other federal tax credits and a host of state tax credits are available as well. Simplifying the tax code is the easiest way to reduce or eliminate loopholes and bring sanity back to the process.

As always, the tax code is as easy to understand as a flying monkey. Perhaps this is another reason why most people leave hundreds or even thousands of dollars of refundable tax credits unclaimed. This is especially true of the poor who don't have tax professionals to help them decipher and access the multiple forms required.

The moral failing belongs to voters and politicians who support nearly every proposed tax credit and then are surprised at the consequences. Until our country comes to its senses, tax management will remain a way to build and protect your family's hard-earned wealth.

from http://www.emarotta.com/article.php?ID=396

Dorothy in Taxland: Overview (2010-06-14)

Dorothy in Taxland: Overview

(2010-06-14) by David John Marotta

Many people who use tax computation software don't understand the changing structure of the U.S. tax code. They fill in the blanks, click Compute and pay the tax. Then they forget about the torture until next year.

Into this dark forest of the tax code, we throw college students and recent graduates. It is almost a rite of passage, better likened to a fraternity hazing than a step into adulthood.

The byzantine rules and regulations of the tax code are carefully crafted to cover up just how much we pay each year. In other words, tax laws are obscure by design. While you are busy trying to translate word problems written in Taxglish, you don't realize the IRS is asking all the wrong questions. Like Dorothy in the field of poppies, you can't seem to stay awake long enough to realize the danger.

A professional tax expert can help you get the correct deductions. But he or she likely won't motivate you to keep the right records unless you understand the benefits for yourself.

The three basic ways to reduce your tax burden are above-the-line deductions, below-the-line deductions and credits. The line in this case is your adjusted gross income (AGI).

Each method is used in one of the four general formulas on the 1040 tax form.

The first formula is "Gross income minus above-the-line deductions equals your adjusted gross income (AGI)."

Above-the-line deductions are subtracted from your gross income to compute your AGI. Therefore, they reduce your AGI, which also lowers your taxable income.

Above-the-line deductions are more common if you are self-employed. But if you are not a small business owner, there are still above-the-line deductions you can take such as stock losses up to $3,000, IRA contributions, student loan interest, moving expenses, alimony and several other items.

Payments to your Health Savings Account (HSA) can also be deducted above the line. In 2010, the family limit is $6,150 in tax-free contributions. One of every 10 patients consumes 69% of health-care costs. The other nine would benefit from an HSA.

The second formula is "AGI minus deductions equals your taxable income."

Below-the-line deductions are more uncertain. Like many items in the tax code, whether they will reduce your taxes depends on many factors.

You can either itemize your deductions or you can take the standard deduction, whichever is greater. For 2010 the standard deduction is $5,700 if you are single and $11,400 if you are married. And whether you itemize or not, you can take additional personal exemptions of $3,650 each.

Home ownership is the most common way to boost your deductions above the standard deduction. The IRS allows home owners to deduct their interest payments each year. If your home mortgage is at 6% and your payments are mostly interest, most of your mortgage is tax deductible. If your marginal tax rate is near a third, the government is paying 2% of your interest, and you are only paying 4% of your interest. For most middle-class families that results in a large tax savings.

If home ownership alone doesn't make itemizing worthwhile, your state and local taxes (including personal property taxes) along with any charitable deductions may push you over the top. Alternatively, if you have high medical expenses that exceed 7.5% of your AGI, you can deduct them as well.

In the third formula, after looking up your taxable income, you compute your total tax. Two different methods are used, and the higher of the two must be paid.

The first method uses the traditional tax tables. The second uses the Alternative Minimum Tax (AMT).

The AMT method of computing tax owed undoes many of the deductions you took in previous steps and turns much of traditional tax planning upside down. Increasingly middle-class families are hit by the AMT, whereas upper-class families pay such a high tax rate already, they are unaffected.

The fourth and final formula is "Total tax minus payments equals the amount you owe or have overpaid."

The critical part of this formula is that payments include not only the money you have given the government but also any tax credits you are eligible to receive.

Deductions only reduce the amount you are taxed on. One dollar of deduction might only be worth 35 cents in tax savings. In contrast, tax credits are a dollar-for-dollar reduction in your tax bill. And some tax credits are refundable. That could mean the government ends up owing you money you never paid in the first place!

Thus tax credits are much more valuable than tax deductions. But most people fail to claim all their legal tax credits and miss opportunities to gain some real wealth redistribution.

Investment management is central to building wealth. But comprehensive wealth management includes tax management as well. A proactive CPA is another essential component of the team. CPAs do more than just fill out your taxes. They may charge a little more, but they can earn their fee multiple times over.

from http://www.emarotta.com/article.php?ID=395

Regular Adjustments Maximize Retirement Success (2010-06-07)

Regular Adjustments Maximize Retirement Success

(2010-06-07) by David John Marotta

Retirement planning consists of a wild scatter plot of potential projections. Navigating successfully through possible outcomes requires regular corrections and adjustments.

Most retirement software runs hundreds of possible retirement scenarios, called a Monte Carlo analysis. Success is defined as achieving 80% or more of investment outcomes where blindly following your planned strategy means staying solvent until you die. Keeping an 80% success rate ensures that your average is much higher than depleting your portfolio. You are prepared to deplete the portfolio, but over half the time you will leave a significant legacy.

Although these projections are useful, they are seriously limited.

One software vendor includes wild stock returns, often called black swan events, that might swamp your portfolio. So the allocation recommendation given the best chance of success for long periods of time is an all-bond portfolio, exactly the opposite of what you would expect.

I pressed the software makers to explain why their program gave such a strange result. They had tried to simulate black swan events in the stock markets. But they admitted they hadn't included any unforeseen bond or inflation events.

They did not consider a possible excessive bond default. And they simply assumed constant straight-line inflation at whatever input was provided. Muni bonds may default en masse. In fact, the United States may go the way of Greece. Alternatively, hyperinflation may return. In any of these scenarios, the all-bond portfolio doesn't seem so attractive for long-term investing.

At age 65, retirement projections are like Lewis and Clark leaving St. Louis heading for the Pacific. They start out due west but know they will need to alter their route as they navigate the terrain. And they can also rely on their Native American interpreter and guide.

Straight-line projections don't work within Monte Carlo. And you can't anticipate every unexpected event. The best approach is to diversify your portfolio to reduce the risks associated with one type of investment and to make continual course corrections.

We recommend a safe withdrawal rate based on age. At age 65 that rate is 4.36%, assuming portfolios with sufficient appreciation and projections adjusted regularly.

Assume you have a million-dollar portfolio as you retire at age 65. Your safe withdrawal rate is 4.36%, or $43,600 for the first year. Inflation averages about 4.5%. A balanced portfolio might earn 5% over inflation, or 9.5% total. So in an average year you would spend $43,600. The remainder of your portfolio would gain $90,858 for an end value of $1,047,258.

Our safe spending rate at age 66 increases from 4.36% to 4.43%. If you'd only earned 3% over inflation, you would receive an approximately 4.5% cost-of-living increase at $45,562 per year. Because you earned 5% over inflation, your safe spending rate increases to $46,394 annually. The extra $832 a year is available because 80% of the time the average return for your portfolio is above our planning.

The market typically appreciates more than planned and you get an increase greater than inflation. But some years the market drops significantly. You then have to hold your spending constant, waiting for your portfolio to catch back up with average market returns.

Our minimal expectation is 3% over inflation. That is the average return of a bond portfolio. When inflation is running at 4.5%, a bond portfolio offers about a 7.5% return. Investing everything in bonds, however, is a poor idea. It gives your portfolio no average excess return to come back from bad bond markets or hyperinflation. With all bonds, your failure rate is 50% or more, too high for a safe retirement plan.

Adding stocks to your portfolio will boost your average return. If bonds earn on average 3% over inflation, stocks earn 6.5% over inflation (11% if inflation is 4.5%). Adding stocks provides an engine of appreciation over 30 years of retirement.

A million-dollar portfolio at age 65 with average returns from a 30-70 tilt toward bonds will produce $4.0 million in spending through age 100. But tilting 70-30 toward stocks will produce $6.1 million. The decision to tilt toward stocks produces over $2 million more lifestyle spending over 35 years.

Investing in fixed income gives you peace of mind. You know your lifestyle for the next few years will be relatively stable and not depend on the whims of an inherently volatile market. Investing in stocks is appropriate when your time horizon is at least five years or longer. Being overly fearful of the markets may jeopardize your retirement lifestyle.

To balance your asset allocation, we recommend keeping the next six years of spending in fixed-income investments and the remainder in stocks. You can keep five years of spending in fixed income if you are aggressive and seven years if you are conservative.

Now your retirement spending is relatively secure for the next six years. We suggest putting the remainder of your portfolio into more volatile stock investments to achieve a better long-term rate of return. Not only do you have a maximum safe withdrawal, you also have a suggested allocation to fixed income to balance the need for six years of stable spending with the need for appreciation to cover the seventh year and beyond.

Thus at age 65, 25% of your portfolio should be in fixed income. This gives you six years of safe spending. Your fixed income allocation could range from a more aggressive 20% to a more conservative 30%. Outside of this range gives you a smaller chance of maximizing your lifetime retirement spending.

Outside of this range you must reduce your withdrawal rate. If you reduce your spending, you can afford to allocate more to fixed income because you don't need the growth. You can also allocate more to appreciation because the investments are really being managed for the next generation. If the markets drop significantly, you won't need the money to meet your lifestyle needs.

Small adjustments in asset allocation and withdrawals provide the constant course corrections necessary to reach your goals. And these regular adjustments give your retirement plan the greatest chance of maximizing total retirement lifestyle spending and the smallest chance of depleting your assets prematurely.

from http://www.emarotta.com/article.php?ID=394

Spending Retirement Income Can Be Risky (2010-05-31)

Spending Retirement Income Can Be Risky

(2010-05-31) by David John Marotta

Calculating safe spending rates in retirement is challenging. Everyone wants to be conservative and be sure they will have enough money. But understanding what numbers to use is not simple.

The most common request we get is for a back-of-the-napkin calculation of future yield, interest or income. People assume they can safely spend the income and thus refrain from touching the principal. But rather than being conservative, this strategy may actually lead people to spend too much.

Consider Michael and Jennifer Madison, a newly retired 65-year-old couple who want to play it safe. They have $1 million that they invest entirely in bonds paying 6%. They believe if they can live off the interest, they won't need any of the principal. Every year they spend $60,000, confident about their conservative choices. But after several years, they begin to feel strapped for cash. They have not provided for the inevitable increase in the cost of living. Too late they realize that inflation is eroding their buying power. The idea of leaving their principal intact is not working.

In just 10 years, the couple's $60,000 only has the purchasing power of $36,000. Their lifestyle has dwindled to 60% of what it used to be. With inflation averaging 4.5% over long periods of time, they need their principal to appreciate. Each year their dollars stay constant, they lose their buying power.

Additionally, although their bond portfolio was getting a 6% return when they started the process, bond yields fluctuate as much as stocks do. When the Madisons find themselves in a low-yield environment like today, they don't know what to do. Inflation has eaten the principal. The Fed has swallowed the yields.

Leaving the principal untouched is even more difficult to interpret when you consider the difference between stocks and bonds. If your investments are in bonds, your principal has no growth to help keep up with inflation. But the interest payment may be higher than you should be spending.

If your investments are in growth-oriented stocks, however, they may pay no dividend at all even if they double in value. Without a dividend it isn't clear what keeping the principal intact means. We don't distinguish between more value from income and more value from appreciation. In either case, spending all of your growth leaves nothing to keep up with inflation.

From an investment point of view, a stock that appreciates 6%, a stock that provides a 6% dividend and a bond that pays 6% interest are equal. Some companies provide a better return by reinvesting earnings in the business. For others it is better to distribute those earnings to shareholders. Attempting to live off the income and preserve the principal often leads people to create asset allocations that are all income and no appreciation. They mistakenly believe this is the best of all worlds. It seems like both overly conservative investing and overly conservative withdrawal rates, when in fact it is neither.

Because retirement may last more than 35 years, you need significant appreciation just to keep pace with rising costs. With inflation averaging 4.5%, spending at age 100 will be more than 4.5 times what it is at 65. So if you get no interest or appreciation on your portfolio, you can spend only a tiny fraction the first year. You will have to save 4.5 times the dollar amount to have the same lifestyle your final year.

Put another way, if Michael and Jennifer stuff their million dollars in the mattress, they will only be able to spend 1.16%, or $11,606, the first year. They must save the remainder for the $54,168 that same standard of living will cost if they live to 100.

Note that because no interest is paid in your mattress, even this ultraconservative 1.16% withdrawal rate is depleting the principal. And any higher withdrawal rate depends on some level of income or appreciation.

Also bear in mind that any specific asset allocation including an allocation entirely to U.S. Treasuries will produce fluctuating returns. Sometimes even bonds drop in value. Long-term government bonds lost 7.03% in 1994 and another 8.6% in 1999. Even short-term Treasuries lost 0.58% in 1994.

Given these shifting returns, the rate of return we assume for our projections is critical. Even if you are ultraconservative, put no money at risk and have a withdrawal rate of 1.16%, you may still run out of money. You may live to be 101 or older. And inflation may exceed 4.5%. There is always a chance of failure in the infinite combinations and permutations of returns, inflation and longevity.

For this reason, financial planning doesn't guarantee with 100% certainty that you can withdraw a certain amount of purchasing power for 35 years and not outlive your money. Instead, astute financial planning seeks an 80% chance and then relies on annual course corrections over the next 35 years to adjust your spending to cover the remaining 20%.

This is an excellent approach. First, keeping 80% of the wild scatterplot of returns exceeding your safe withdrawal needs means the average is much higher than you need. Most of the time, returns that fall in the bottom 20% are more than compensated by the 80% that do not. And because the average return is higher than you need, your portfolio will most often be able to make up for poor returns early in retirement.

Second, if 80% exceeds the needs of your safe withdrawal rate, it produces a lot of excess returns. So although you are planning to deplete the portfolio, 80% of the time you will leave a significant legacy. What you are trying to accomplish is your best chance at enjoying your preferred lifestyle. And your best chance of achieving it is aiming to deplete the portfolio in less than 20% of the wild scatterplot of returns.

This 80% success rate sounds more threatening than it actually is. In truth, it means you will be able to increase your spending rate by more than inflation 80% of the time. But 20% of the time, you will have to defer any spending rate increases by inflation until excess returns have helped your portfolio rebound. These annual adjustments allow a near 100% success rate by adjusting your standard of living by a small amount based on how your portfolio has actually performed.

At age 65 the safe withdrawal rates using this method are 4.36%, or about $43,600 for a million-dollar portfolio.

from http://www.emarotta.com/article.php?ID=393

Avoid the "Ring-of-Fire" Countries (2010-05-24)

Avoid the "Ring-of-Fire" Countries

(2010-05-24) by David John Marotta

A few months ago Bill Gross, co-founder of PIMCO and the country's most prominent bond expert, wrote a provocative monthly newsletter. He evaluated countries based on their total public sector debt as a percentage of gross domestic product (GDP) as well as their annual deficit, which is making matters worse. Gross singled out those countries heaping significant deficits on their mountain of debt and called them "The Ring of Fire."

The eight countries he identified were Japan, Italy, Greece, France, the United States, the United Kingdom, Ireland and Spain. The International Monetary Fund (IMF) cautioned that rising government debt has replaced financial industry stress as the biggest threat to the global economy. Gross warned his readers to watch "the U.S. with its large deficits and exploding entitlements." We recommend that you reduce your investments in these countries.

Our own government spending spree was not necessary. A Heritage Foundation study concluded that the stimulus money spent by countries had a negative short-term correlation with that country's GDP. In other words, stimulus money may even have had a slight negative short-term effect as well as a stronger negative longer term effect.

The IMF study agreed, stating, "Longer-run solvency concerns could translate into short-term strains in funding markets as investors require higher yields to compensate for future risks." In other words, we've taken short-term financial illiquidity and turned it into a long-term government deficit, which in turn raises the cost of short-term liquidity.

If you've lost your job or are struggling to live within your budget, running up your credit card never helps. It may make you feel better momentarily, but it doesn't even really help your situation in the short term. Spending beyond your means only makes matters worse. And government spending is making everyone miserable.

A small amount of government spending is necessary for infrastructure, which appears to boost economic activity. Successfully funding the rule of law provides the economic freedom necessary for economic activity. The optimum amount of spending appears to be relatively small, perhaps about 18% of GDP.

In every economic analysis, greater government spending is associated with weaker economic growth. The Keynesian views of economic stimulus have been largely discredited, although its ideas continue to be misused politically to support massive government-spending programs.

Government intervention continues to do more harm than good. This past year it took a common recession and prolonged it into a more permanent malaise. GDP growth, which has historically averaged 6.5%, is liable to slow to a more European rate of 3 to 4%. Official unemployment numbers will lower but only as people drop out and are no longer counted. Real unemployment is likely to remain high for some time.

Lest you think these policies don't affect you, they do. Part of Greece's austerity measures include raising the retirement age 14 years. Lower U.S. stock returns could have the same impact on your ability to leave the workplace. For each 1% less in return over your working career, you will have to retire seven years later to achieve the same retirement lifestyle.

Countries obligated to impose austerity measures illustrate the natural consequences of spending money you don't have while taxing and regulating wealth creation. Politicians take the credit for enacting feel-good programs they can't pay for, and then they scapegoat private enterprise to cover their misguided thinking.

Reduce your investment in these countries. Put your money where the entrepreneurial spirit is rewarded and the welfare state is discouraged, not the other way around. We suggest lightening up on foreign investments that primarily just follow the MSCI EAFE index.

EAFE stands for Europe, Australasia and the Far East. It represents all the developed countries outside of the United States and Canada. This includes large investments in all seven of the non-U.S. ring-of-fire countries. The EAFE consists of 22% Japan, 21% United Kingdom, 10% France, 4% Spain, 3% Italy and 1% Ireland and Greece. In total, 61% of the EAFE index is invested in ring-of-fire countries.

But before you stop investing in foreign stocks altogether, remember that 100% of domestic stocks are invested in the eighth ring-of-fire country, the United States. And we need our own austerity measures. The total compensation package for federal workers in the United States is $108,476--a full 55% higher than workers in private industry whose total compensation amounts to only $69,928. Going forward may be one of the times when a strong tilt toward specific foreign countries may provide superior long-term returns.

Gross advises seeking return where "national debt levels are low, where reserves are high, and where trade surpluses promise to generate additional reserves for years to come." This suggests investing more in emerging markets such as Chile, China, India and Brazil.

It also includes emphasizing countries with economic freedom such as Hong Kong, Singapore, Australia, Switzerland and Canada. Or mostly free countries with lower debt such as Denmark, The Netherlands, Finland, Sweden, Austria, Germany or even Norway. These countries should outperform their debt-laden counterparts.

As Gross ended his newsletter, "Beware the ring of fire!"

from http://www.emarotta.com/article.php?ID=391

Should you invest IRA Funds in Real Estate? (2010-05-21)

Should you invest IRA Funds in Real Estate?

(2010-05-21) by Matthew Illian

Q: I am looking for a way to get into the distressed real estate market. What do you know about using the money in my IRA or 401(k) money to invest in real estate?

Sincerely, Cash Poor and IRA Rich

Dear Cash Poor,

You have good financial instincts. Real estate could be a great investment right now, and we are currently increasing exposure to this sector. But the risks and accounting red tape when making direct investments using IRA or 401(k) money should be avoided.

Cashing out a traditional individual retirement account (IRA) or 401(k) will trigger a taxable distribution and usually an additional 10% early-withdrawal penalty for people younger than 59 1/2. I don’t recommend this approach because the penalty is high and the investment results unpredictable. One recent belief that I hope has been forever scorched from the American consciousness by the recent recession is the idea that real estate investments always increase in value.

Another ill-advised option would be to transfer your IRA to a self directed custodian that allows for real estate purchases. These transactions have been gaining popularity, but I believe most investors should avoid these complex techniques. You will likely lose the power of leverage because few banks lend money to an IRA. Additionally, you can’t deduct property taxes and you can’t use depreciation. When an IRA holds the property, an individual is not allowed to cover an expense--like buying paint or new granite countertops-- out of personal funds or it will likely be deemed a prohibited transaction in the eyes of the IRS and could cause your entire IRA to be taxed.

Many 401(k) plans allow you to take a loan of 50% of the vested account balance up to $50,000. Borrowing from your 401(k) is penalty free, unless you don’t pay the money back. Then the usual early withdrawal penalties apply. You are charged interest on the loan because your 401(k) is the bank, and the interest gets added to your account. Most plans also require you to repay the loan within five years and definitely before you change employers. I would suggest not tapping your 401(k) plan.

Don’t get me wrong. I believe this is a good time to invest a portion of your portfolio in real estate. In fact, after being out of the real estate markets for several years, our firm is now recommending a 4% allocation in diversified portfolios. If you don’t have the cash or financing available to purchase directly, consider investing your IRA or 401(k) money in a real estate investment trust (REIT). These investment pools are typically publicly traded and run by real estate investment professionals. You can invest directly in specific REITs or indirectly through diversified mutual funds and exchange-traded funds (ETFs). If you are looking for an easy recommendation for an investment vehicle, try the Vanguard REIT ETF (symbol is VNQ). The expense ratio is only 0.15%, and the effective yield is 3.5%. This is by far the simplest and most cost effective way to take advantage of this trend. If you do invest in real estate, remember it is a long-term investment, and like all such investments, you will have to give it time.

from http://www.emarotta.com/article.php?ID=392