Should I Use a 401K Disbursement or Loan to Pay Off Mortgage?

Hypothetical Question: I’m 55-ish in the Midwest and my mortgage end is in sight. I’m comfortable with my 401(k) balance. Does it make sense for me to cash-out just enough to pay off the house? ($40,000, out of a 401(k) balance of apx. $800k.)

[Remember that retirement balances and expectations are different based on where you live.]

No. Here’s why, but with one condition:

If you take a withdrawal from a 401(k) account before you are 59 and a half, it will immediately be assessed a 10% tax for early withdrawal. The funds you take out of your 401(k) also will be taxed like earned income.

In contrast: That $40,000 or so of 401(k) income would keep growing at certainly more than your mortgage interest rate.

ALSO, More Taxes: What you put into your 401(k) were pre-tax withholdings from your paycheck, and the interest you earned on that 401(k) retirement account is also pre-tax. So, regular taxes will also be owed, on top of your current income tax bracket. For most “seasoned” para-professionals and credentialed professionals in the 55-ish age range, that would probably be 22%-35%. When you add the 10% penalty tax, that’s a big loss.

Projected 2025 tax brackets from the IRS.

Even if you didn’t take advantage of the super-low interest rates before Covid and have one in the 6-10% range that were more common 25 years ago, you will save so much more by not getting that high-priced cash advance. Keep the mortgage.

But what about a 401(k) loan? Well, this will still cost you about 8-10% per year, but may vary depending on your 401(k) provider. However, that is still preferable to 10% plus 20-30%. But, while you are repaying your own investment account, it will see less growth.

One Condition:

What if it’s an emergency? When it’s a health-care level emergency, or you’ve lost your job (or might) and don’t want to lose your home – you do what you need to. However, keep in mind that if you are hoping for a secure 20-30 more years, you need to protect your nest-egg.

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If we could all think ahead when we were 20 years old, instead of 55 and worried about the future, it would be much easier for us, and for society. Let’s get better financial literacy in schools of all levels. Even 35 year-olds need to start thinking about retirement savings.

Alternative Perspective: Paying off your home can bring a great sense of relief and de-stressing. Many financial advisors have, begrudgingly, admitted that this can be worth the lost retirement investment income. Imagine: No house payment (aside from property taxes) ever again!!!

What are your thoughts on this?

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