Can I use a 401(k) form to pay off a mortgage?

pay off your mortgage with 401k

pay off your mortgage with 401k

The government offers several incentives for retirement accounts such as 401(k)s. For example, they are tax-deferred investments, which means you won’t pay taxes on them until you take them. 401(k) deposits are also not considered taxable income during the year you made them, so you can use them to reduce your tax liability. In the same way that they encourage retirement investment, the government punishes people who forgo their retirement savings. But in some cases, it may make sense to look into the 401(k) early. One such scenario is the payment of a mortgage loan. Before you decide to take money from your pension fund to pay for your mortgage, you need to weigh the pros and cons. You can also get expert advice from a financial advisor about your unique situation.

Should you pay off your mortgage with a 401(k)?

Paying off your mortgage can seem like a relief, especially if the debt is hurting your mental health. But you don’t want to make that decision solely on that emotion. Your pension is your nest egg. Before you dive into your retirement savings, there are four questions you need to answer.

1. How old are you?

If you are under the age of 59.5, you will face an additional 10% penalty for early waiver of your 401(k). This is a huge hit that makes paying off your mortgage not worth it. This means that if you borrow $50,000 to pay off your mortgage, you will automatically be fined $5,000. This is pre-tax too, so your cash on hand will be even less.

2. How much do you owe?

The amount you owe on your mortgage depends on two factors. For example, let’s say you owe $200,000 on a mortgage. If you pay off your mortgage, not only will you not have to pay the mortgage, but you will also avoid paying $200,000 in interest. However, if you take $200,000 from your 401(k), you will have to pay distribution tax. For $200,000, this could result in thousands of taxes.

3. How much did you save?

Depending on how big your stash is, paying off your mortgage with a 401(k) might make sense. However, first look at your other savings or assets. If you need to extend your 401(k) until retirement, it may make sense to keep it invested and use other assets to pay off your mortgage.

4. What is your expected rate of return?

This is big. If your 401(k) plan is reliably delivering a 7% return, you should think before you touch it. This rate of return is free money. For example, if you have $1 million in your 401(k) at 7% APR, you make $70,000 a year. As you dive into your 401(k), this annual payment will decrease. If you take out $300,000 to pay off your mortgage, your annual increase drops from $70,000 to $49,000.

Pros of paying off a mortgage with a 401(k)

pay off your mortgage with 401k

pay off your mortgage with 401k

When you pay off your mortgage, regardless of the method, it can be beneficial and gives you a lot of breathing room in your finances. Here are some of the most important points to consider and which can be considered positive in the decision-making process.

  • Reduced monthly expenses: There’s something to be said for not having to pay your mortgage every month. If your mortgage payment is $2,500 a month, that’s $30,000 a year you don’t have to worry about. If you have a fixed income, eliminating these mortgage costs can significantly reduce your recurring expenses.

  • Avoiding or reducing interest payments: By paying off your mortgage early, you will reduce the total amount of interest you pay. For example, if you have a 30-year fixed-rate mortgage of $400,000 at 7% per annum, you will pay $558,035.59 in interest alone for those 30 years. The younger your mortgage, the more it affects. This is because of how mortgages amortize. Borrowers pay the interest they owe upfront, gradually paying off the bulk of the principal over the term of the loan. If you’re in the last five years of your 30-year mortgage, you’ve already paid most of the interest. However, if you are in the first five years of a mortgage, you still have the bulk of the interest ahead of you.

  • Planning your estate: Owning your home to the fullest can make life easier for your heirs. When planning for an inheritance, you may decide to pay off the mortgage so that your heirs receive it at full cost. As you near the end of your life, full home ownership can protect an asset for those you leave it to.

Cons of paying off a mortgage with a 401(k)

Using your pension funds always comes with some potential downsides to consider to make sure it’s the right solution for your situation. Here’s what you need to know before moving forward.

  • Reduced pension assets: Paying off your mortgage with a 401(k) can significantly reduce your retirement assets, especially if you have a large balance to pay off. For example, if you pay off a $200,000 mortgage and have $1,000,000 in retirement savings, that’s 20% of your pension.

  • Loss of growth potential for pension assets: If you earn a 7% return on your retirement savings each year, reducing your 401(k) will reduce your income. This annual gain can be a big part of what allows you to retire. By taking a significant chunk to pay off your mortgage, you are cutting back on the income you can earn.

  • Significant tax bill: Perhaps one of the biggest deterrents to paying off a mortgage with a 401(k) is your tax bill. Remember that any money you withdraw from your 401(k) form will be treated as income for your income tax. This means that if you take out $200,000 to pay off your mortgage, you will pay taxes on it. This may result in you moving to a different tax group, raising your effective tax rate. If you’re going to pay off your mortgage with a 401(k), be prepared to pay a huge tax bill.

bottom line

pay off your mortgage with 401k

pay off your mortgage with 401k

Paying off a mortgage with a 401(k) may make sense in certain scenarios. This takes the emotional weight of debt off the table, and it can also make it easier for your heirs to plan for an estate. However, you need to carefully weigh the cons. You will end up paying taxes, and you don’t want to spend your retirement savings to the point where it affects your quality of life.

Retirement and Mortgage Tips

  • Want to create a financial plan that will multiply your money and secure your retirement? You may find it helpful to speak with a financial advisor. Finding a financial advisor is not difficult. Free SmartAsset Tool matches you with up to three vetted financial advisors that serve your area and you can interview their advisors for free to decide which one is right for you. If you are ready to find a consultant to help you achieve your financial goalsstart now.

  • Use the SmartAsset Mortgage Calculator to calculate your new mortgage payment, see how your mortgage is amortized and how much interest you will pay over the life of the loan.

  • Use the SmartAsset Income Tax Calculator and you can estimate how much tax you will pay due to a large withdrawal from your 401(k).

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The post “Using a 401(k) Form to Pay off a Mortgage” first appeared on the SmartAsset Blog.

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