Ask SmartMoney: 401(k) Loans, HSAs, Vacation Homes

QUESTION: Is now a good time to borrow against my 401(k) to pay off other loans? My current investment return is 5 percent, while the interest I'll pay is 9 percent.
— Sean Guy, Dallas

ANSWER: From a pure numbers perspective, taking out a 401(k) loan to pay off, say, high-interest credit card debt may seem like a no-brainer. After all, with a 401(k) loan, you're paying yourself back the interest, whereas with credit card debt, you could be paying 15 percent or more to the bank. Plus, in today's market, that 9 percent is almost assuredly more than you'd make had the money stayed in your account.

That said, most planners shudder at the thought of raiding tomorrow's nest egg to fund today's financial indiscretions. "Numberwise, it may work out, but I don't always like this idea," says New York-based financial planner Scott Kahan. The biggest concern: If you leave your company for any reason, you'll need to pay back that loan in full, usually within 30 days — or pay ordinary income tax on the withdrawal, plus a 10 percent IRS penalty if you're under age 59 1/2. Bottom line? This move is foolish if you're likely to rack up more debt, have job security concerns, or are paying off low-interest or tax-deductible loans. But in the right scenario, you may come out financially ahead.

QUESTION: Everyone writes about the tax benefits of health-savings accounts. But what if you never incur large medical expenses? Can you still tap the money in old age?
— Ezra Greenberg, New York

ANSWER: Nobody's that healthy — especially over their entire life. These super-tax-friendly accounts — contributions are tax deductible, and withdrawals used for medical expenses are tax free — are paired with so-called high-deductible health plans, which in 2008 are defined as plans with a $1,100 deductible for individuals or $2,200 for family coverage. So any medical expenses you incur that either go toward your deductible or aren't covered by insurance can come from your health-savings account. (You don't need large medical expenses or a chronic illness to make these accounts worthwhile.) What's more, there are no mandatory withdrawals — ever — so your account can build indefinitely. Annual contributions are $2,900 for singles, $5,800 for families.

But let's say your savings do exceed your medical expenses. Withdrawals taken for nonmedical costs are taxed at ordinary income rates — and if you're under 65, you'll owe a 10 percent penalty to boot. That makes tapping the account in "old age" pretty much the same as taking withdrawals from a tax-deductible IRA. So while you'll save the most if your withdrawals are used for health care costs, they aren't bad when used for other expenses.

QUESTION: Do the capital gains tax breaks extend to vacation-home sales? Our vacation home is in New York.
— Janis Londraville, Venice, Fla.

ANSWER: Unfortunately, your sweet vacation home may look more like a tax trap when you sell: First of all, the generous capital gains exclusion ($250,000 for singles, $500,000 for married couples) does not apply to second homes. Second, if you rented out the home and took a depreciation deduction, those previous deductions become taxable at a maximum rate of 25 percent when you sell, says Dan Yu, a director with the Personal Wealth Advisors group at Eisner LLP. But wait, there's more: You're going to owe New York State tax as well.

How to minimize your hit? Well, you could move into your vacation home for two years to qualify for the capital gains treatment allotted to primary homes. Or if you're looking to buy a new vacation home, you could see if you're eligible for something called a 1031 exchange. Here you get to roll over your untaxed gains into your replacement vacation property. This strategy applies to properties that were used primarily as rentals, however. Rethinking that sale yet? New York is quite lovely in the summertime.

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