Don’t Use 401k Withdrawal to Pay Off Mortgage

Q: How can we take money out of 401(k), pay off our mortgage and not pay taxes on it all if we do it all at the same time? Can any of it be deferred? The amount we’d want to take out is $105,000?

A: Unless you’re in danger of losing your house, you generally shouldn’t take money out of a 401(k) and use it to pay off a home loan.

Why? Because your money is growing inside your 401(k) at a faster rate than you’re paying out for your loan. Also, your mortgage interest may be deductible if you itemize on your federal income tax return.

If you’ve recently refinanced, you’re probably paying less than 5 percent for your mortgage. (I just refinanced to a 15-year at 3.75 percent.)

If you itemize, your net interest rate is somewhere around 3.5 to 4 percent. That’s basically like free money, and over time you’ll do a lot better by keeping the cash inside your 401(k).

In addition, if you’re under 59 1/2, you’ll not only pay taxes, but you’ll also pay a 10 percent penalty on your withdrawal.

So the real question is why would you want to take out that much money to pay off your mortgage? And if you did, that much of a withdrawal from your 401(k) would probably put you in a higher tax bracket causing you to pay even more federal income taxes on the amount you take out.

The only way to get tax-free cash is to borrow from your 401(k). But, again, I don’t recommend it. If you lose your job, you’ll have to replace all the cash within 60 days, plus you’ll be losing out on any return your retirement cash would generate inside your 401(k). The risks are extremely high that you could be caught short and wind up losing your home if you can’t come up with enough cash.

My suggestion is to keep your 401k money where it is and focus on finding additional ways to save in your budget to throw more cash at your mortgage.

4 thoughts on “Don’t Use 401k Withdrawal to Pay Off Mortgage

  1. Unfortunately many investors have had poor returns from their retirement accounts and are frustrated. Investing is anything but a sure thing.

    However, the negative tax consequences of taking such a large one time withdrawal would greatly increase the cost of the pay off, in terms of withdrawn pre-tax dollars, to not be an effective use of a taxable retirement asset.

  2. Our government will confiscate our 401k’s to offset our country’s debt. The government will hopefully be a little slower to seize private property. I would rather have a tangible asset.

  3. I bought my house 2 years ago, taking a FHA loan for $270k. I refinanced within a year from 5.5 to 4.5 at no real cost, so my current Mortgage payment is about $2000/month. This includes a $200/month FHA MIP. My original plan was to have the MIP removed within 2 years by paying extra each month, but that has not been possible due to my partner not being working, so I am the only one providing at this point.

    I have a Fidelity 401k through my employer that has essentially lost 15-20% in the past 12 months. The last time I saw any positive return on it was for a brief 2 months period.

    At my current rate, I do not see myself being able to pay any extra to my mortgage principal, so I would think I’m stuck with the MIP for another 3-5 years? Would it make sense for me to make a hardship withdrawal from my 401k to put enough towards my mortgage principal to remove the MIP? I know there are penalties for taking the money out, but with it losing money every month (already down 5% this year alone) and the $2400/year for the MIP going nowhere, does it make sense to perhaps take that hit with the uncertainty of the market and put that money to work paying off my debt instead?

  4. Im 62 and would like to retire at 65. The only payment I have is Mortgage, 1400.00 a month. I have about 200K in one of two 401 Ks, and I owe about 125 K in principal on my mortgage.

    I have a second 401 K that Im putting 20% of my current pay into. It only about a year old. I belive I would be better off to pay off my Mortage with the first 401 K and put those 1400 per month payments in to savings. I really like the idea of haveing no house payment. Worse case I belive my wife and I could do fine if we only had social security coming in if the house was paid off

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