Should I Use My 401K to Payoff Mortgage? Watch This Before Deciding!

Video: Marginal tax rates explained: https://youtu.be/uCFmdlBvQXI

2018 tax brackets: https://www.irs.com/articles/2018-federal-tax-rates-personal-exemptions-and-standard-deductions

Recently a subscriber e-mailed me asking a question regarding their parent’s 401(K). There question was as follows:

Hi Mike, my mom has been retired from the workforce now for several years and is wondering if it would be wise to use her 401(K) to pay off the existing mortgage on her home?

The short answer is it depends, but by the end of this video I believe you will the tools and information necessary in order for you to make this decision for yourself.

1. In this video we are going to discuss the pros and cons as well as factors that should be taken in consideration before you start withdrawing from your 401(K) to pay off your home.
2. Secondly if you decide you want to go through with paying off your mortgage early with your 401(K) we will discuss a strategic way to go about that is process so you can pay the least amount of tax possible.

Three pros of paying off your home with your 401K include:

1. You will have peace of mind knowing you own it out right.
2. You will be saving money on interest
3. You will need less money to live on going forward because you will no longer have a mortgage payment.

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Three cons of using 401(K) to pay of mortgage

1. You give up the potential compounding interest impact of your 401(K) investments and possibly trading your investments for a lower rate of return based on the home mortgage interest rate.
2. Assuming you do not have other sources of income outside of your 401(K) You run the risk of becoming house rich and cash poor which could potentially put you in a position later on where you have to take on debt because you have no other available funds.
3. Without careful planning you might pay more taxes than you need to on your 401(K) distributions in order to pay off your mortgage.

Specific factors that I would suggest you take into account in this decision making process:

1. What is your annual mortgage rate?

2. What is average annual rate of return on your 401(K) over the past 5 – 10 years? Is it higher or less than your mortgage rate? (I find that most people I speak with have absolutely no idea what the answer to this question is.) So if you do not know ask someone to help you figure this out or call the brokerage company where your 401(K) assets are invested.

3. What is marginal tax rate since you retired? This is important when determining how much tax you will have to pay when you withdrawal from your 401(K). You can get a rough idea of your income tax rate based on the 2018 tax tables. I’ll provide a link in the description section of this video where you can go to find those. I’ll also link up a video I did to give you step by step guide lines of how to determine that.

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4. How much would actually you need to withdraw from your 401(K) to pay off your home net of taxes?

5. Do you have emergency fund of 3 – 6 months worth of expenses saved up for emergencies that arise?

6. Do you have other sources of income to get by besides social security? How will you get by if emergencies arise?

7. Are you ok with taking risk in the markets by keeping your money invested?

If you decide that ultimately you want to use your 401(K) to pay down your mortgage this is how I would suggest you go about doing it.

– First determine your outstanding mortgage balance.

– Next, remember that your 401(K) distributions are taxed at ordinary income tax rates. Ordinary income rates are based on your marginal tax rates which follow the tax brackets I mentioned earlier in this video.

– What you want to avoid is paying more tax on your 401(K) distributions than you need to.

– To minimize your tax burden you want to do some basic tax planning and to the best of your ability determine how much total income you will have for the year from all sources of income before pulling out additional amounts from your 401(K).

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– Based on that income projection determine how far away your income is from the next tax bracket.
– Now, consider pulling a smaller amount of extra money from your 401(K) so you stay under the next tax bracket threshold. This will allow you to pull this money out of your 401(K) at a lower tax rate.

– The next year do the same process again, and keep doing this process until your mortgage is completely paid off.
– By spreading out your distributions from your 401(K) and paying off your mortgage a little more slowly you might be able to save hundreds or even thousands of dollars of additional income taxes that you would have otherwise paid had you taken the money out all at once.

My Website: Moneyandlifetv.com
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Money and Life TV : Should I Use My 401(K) to Payoff Mortgage? When to Use 401(K) to Payoff Mortgage if Retired

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12 COMMENTS

  1. Just spent a year figuring all this out by myself, through research. I wish I'd been subscribed to your channel last year–I would have saved myself a lot of time! Your advice is excellent. Reyour comment that you don't totally see yourself taking money from you 401K to pay off you mortgage, I will say that after I took retirement, that paid-off mortgage became much more attractive to me (the "pros" you mention) and I don't regret doing that. But I'm really careful to keep my emergency and down-market cash accounts funded, so that I don't have to deplete my fairly modest 403B account in a down market. There's so much to think about, and you've explained things very clearly. I'm recommending your channel to some of my friends–all women, like me, who weren't taught these things when we were just starting out. Thanks!

  2. Personally, paying off the mortgage by the time you retire is a good idea. Try not to do any cash out refinancing or anything that will stretch a plan to pay off the mortgage by the time you are going to retire. Taking on risk while still working I suppose makes sense to grow the assets to the point you don't have to grow it during retirement. If you are still working and whatever plan that you originally had didn't work out as well as you would have liked, you can try to work a bit longer to try to make up for lost ground–the so called plan B. That allows you to take on less risk during retirement where you wouldn't have a plan B to fall back on. If you pay off the mortgage before you even draw dollar one from the 401(k) plan, you completely avoided the issue to begin with. That's the ideal vision but in the real world, people have competing priorities. By the time they cut everything they can on their expense, they still couldn't pay off their mortgage and fund their 401(k) plan at the same time. So people wind up in situation where they have no other way to pay off the mortgage than to use their 401(k). You can continue to try to leverage your investment by paying the minimum on the mortgage and leaving the investments as long as they can. There's the 70 1/2 Required minimum distribution rule to consider when planning such strategy. It's still a leveraged position so paying off the mortgage still may make sense. One thing that might be counter productive is to invest conservatively in a 401(k) because of your age and still be caring a mortgage. If you are going to do that, consider taking the money out that would be a in the conservative portion of the 401(k) and use that to prepay the mortgage. That way you avoid borrowing in the form of your mortgage only to lend it to a corporation or government in the form of a investing in bond. The tax deduction on the mortgage interest is over rated. The interest portion declines over time as you pay down the mortgage at the same time the standard deduction is growing due to inflation. At some point, the benefit becomes too small to be worth bothering with. And no, I'm not stating it because Dave Ramsey is saying to stay out of debt. I'm stating this because based on the risk reward relationship and the lack of real tax benefits to off set it, in most cases, it does make sense to pay down the mortgage by the time you are retired.

  3. What do you think about the reversible mortgage ,where the government gives you a loan and they pay off your mortgage. U take that money and invested because most of the time your children once they grown-up they move in today own neck of the woods. I look at that's an investment why not get the best out of that home investment in your golden age? P. S. Great video!!

  4. Whats going on everybody, happy Sunday! Big shutout to my friend and subscriber who suggested this topic. I find the question to of whether or not to payoff your mortgage to be a very common one. Lots of people have asked this question, including many of friends. I hope after watching this video you will be able to come to the right conclusion for yourself.

  5. Mike, In your example you did not include the mortgage payment that you no longer have to pay as a benefit for paying off early. At $1000 /month that is $24K per year that would be reducing the difference. Just a thought. Thanks

  6. Awesome mike!! 🙂 one thing I would like to ask, can’t you have the option to have the brokerage or custodian account withhold taxes on your distribution and send you a check net of taxes?

  7. Thanks, Mike. As always, great food for thought with the #s to back them up.
    My thoughts, if someone is retired, do you recommend that person move their 401 to their traditional IRA? This is what I did, which I found gave me so much latitude and options to my investing goals; Not to mention, like TD, they don't have an annual maintenance fee, which many 401Ks do have.

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