Should a 0K mortgage @ 6% be paid off with 0K withdrawn from a 401K at retirement?
Should a 0K, 30 year mortgage @ 6% be paid off with 0K withdrawn from a 401K account at retirement?
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In general taking money out of a 401k to repay a loan is a bad idea for a number of reasons.
Taxes and penalties if you are under 59 and 1/2 you will pay a 10% penalty on withdrawals from a traditional 401k plan. Then you are going add the amount you withdraw to your income in determining your current tax bill. If you make a large withdrawal you will likely push yourself into a higher tax bracket and will end up paying additional taxes than if you made several smaller withdrawals or waited until retirement when your income would presumably be lower. Taxes and penalties will mean you will need to withdraw ~225k in order to pay taxes and penalties while still having 150k to pay toward the mortgage (this assumes you are single and have no other income).
You miss out on the growth your 401k could have had.
Lack of diversification the average person has the majority of their net worth tied up in their home and by paying off your mortgage you are putting even more of your money into residential real estate.
By moving money from a 401k to your personal residence you could also lose some protection from creditors and lawsuits. Retirement accounts are generally off limits to creditors where as your house is limited by the homestead exemption (varies greatly from state to state).
There are a few times when it might makes sense to use 401k money to pay off a mortgage. If you are older than 59.5 and have little tolerance for risk it might make sense to take the amount of money between your current income and the next higher tax bracket and "invest" the money in your mortgage each year. You would still want to avoid taking out a large chunk at one time though to avoid pushing yourself into a much higher tax bracket.
There are a few considerations:
Purely Financial:
If you think you can make more than 6% (adjusted downward for the tax benefits of home interest deductions) on that 0K then no. Otherwise yes.
Update: A good point was made in another answer, if the 401K is not a ROTH, the tax consequences of withdrawing a lump sum like that will probably tip the balance in most situations towards not paying off the house.
Risk:
Paying off a mortgage reduces your liquidity. That is, it is much harder to pull your money out of a house note than to sell off some stocks/funds/cds. Put simply, if you run into trouble and need a lot of money quickly would you rather have a paid off house or 0K in the bank/near-cash investments?
Disclaimer - I am going to refer you to Fairmark's web page. I have no relationship with this company, but the page is great to show you your marginal rate. Updated for 2011 and you can go back to prior years.
I would first ask you what tax bracket you are in. And then, I'd likely suggest you withdraw only enough to 'top off' that bracket and pay the mortgage down. Doing it all at once can create a bad situation, where you pay far more in taxes than you might otherwise.
I'd also ask- are your property taxes high enough to put you into itemized deduction land? If so, you have a bit of math to do. That 6% may be costing you 4.5% or less, and long term, you are better off not paying early, although I admit, I prefer to be mortgage free by retirement.
I'm going to assume that the 401K is not a Roth. If that's the case, no, you should not withdraw from your 401K to pay off your mortgage.
You will pay taxes on the withdrawal as if it is income, and that loss will far exceed the 6% you are paying in interest on the mortgage (which is deductable, so may actually be less than 6% all things considered).
The calculation is really more complicated, but in general, this sounds like a bad idea.
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