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I've been considering paying off my mortgage with my 401k balance. Some particulars, I'm in WA state in the US, and I'll turn 60 in about a week.

I have enough in my 401k with my current employer to pay off the balance of my mortgage. Maybe not quite pay it all the way off, but well within a few thousand either way.

FWIW, I have other investments as well that total roughly $300k that are completely separate from my 401k funds.

My mortgage is currently at 2.75% on roughly $138k-ish balance (I don't have a pay-off amount from my mortgage company, so I'm just looking at the current balance). It's a 15 year fixed loan that matures in 2028. The house is currently worth somewhere between $450k & $500k.

My 401k YTD performance is 16.5%, and 1 year is 10.7%. on a balance (today) of $150k-ish and I'm currently putting 25% of my paycheck into 401k (with a 4% match from my employer).

I'm looking at retiring in about 5 years, sooner if possible.

My question is, given these variables, is it wise (or possible) to pay off my mortgage with my 401k, then bump my 401k up significantly so I hit the maximum contribution of (currently for >50 year olds), $25k / year. I'd also max out Roth IRA contributions for my wife & me as well as our HSA funds (which can also be invested if you don't use them) which are similarly tax exempt.

In my head this makes some sort of sense, but I'm not a financial person.

Is this (A) possible, (B) advisable, and (C) what pitfalls might there be (taxes, penalties, market instability, etc.)? I don't know how to do this calculation so I'm hoping I've provided enough information to get the help.

  • Does the employer even permit this? Many do not allow a withdrawal while still employed. Are you planning to stay in the house or sell it once you retire? – JoeTaxpayer May 17 at 20:43
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    I feel like you don't have near enough in your retirement accounts now unless you also expect a pension. Start throwing extra money at the mortgage (after maxing out the retirement account contributions), and re-evaluate in a few years. – mkennedy May 17 at 23:39
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    Why not use your other investments that aren't tax advantaged to pay for the mortgage? Also you can take up to 50k loan from the 401k and pay yourself the interest instead. Granted this means less market exposure – Chris May 18 at 0:41
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    Would I liquidate money earning ~10.7% and pay income tax on it to extinguish a 2.75% debt? Never. – chili555 May 18 at 1:50
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    I'm sure an answer will show up soon covering this in more detail, but consider that your earnings in 401k are effectively compounding. You can't just count the money you're withdrawing from the 401k; you also have to consider that the earnings aren't being reinvested to earn even more in the future. Given that your 401k is earning a much higher rate than the loan is accumulating, it would appear that's a bad trade off. – jpmc26 May 18 at 12:52
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I will say, it is

(A) Possible

(B) No, as you are getting very cheap money at 2.75% on your mortgage and your 401K is giving you 10+% and even if it decline to average of 7% or less, you are still making a lot in long run. And if you withdraw funds from 401k, you will be paying taxes.

(C). As outlined in B, you will pay taxes on 401k withdrawal as those withdrawal will be in bulk and will raise your tax bracket for the year that you withdraw funds.

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    I would be cautious about a phrase like "raise your tax bracket". Many people don't understand marginal taxation, and misinterpret this and make the classic mistake of thinking that entering into a higher tax bracket will raise the taxes on all of your income – Alexander May 18 at 1:25
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    @Alexander: That said, those same people don't understand that they pay way less than their advertised bracket on their total income, and that additional income is taxed at their highest bracket. They get used to knowing they're in, say, the 25% bracket, but seeing deductions that, if they worked it out, are in the 15% range relative to total pay. When they get a bonus, windfall, or withdraw from 401(k), they're shocked at how the taxes increase way faster than before. The taxes don't go up on money in the lower brackets, but the overall percentage paid skyrockets relative to expectations. – ShadowRanger May 18 at 3:55
  • @Alexander The details don't matter that much. It still greatly reduces the value of withdrawing from your 401k, enough that anyone should think three times and know exactly what they're losing before doing it. – jpmc26 May 18 at 12:46
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    @Alexander: David is saying that most decisions affect taxable income on the margins. It's really only a handful of decisions about retirement savings (e.g. Roth vs deductible 401k) that result in future income across the entire spectrum of brackets. – Ben Voigt May 18 at 23:57
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    @Alexander If you're choosing whether or not to take more income, it will be taxed at the marginal rate. If you're choosing whether or not to do something that results in a deduction, it will be credited at the marginal rate. For the vast majority of decisions people make, only the marginal rate matters. This is an important component of civil literacy because it's the operative principle when looking at tax policy and for the vast majority of decisions people make, it's the correct viewpoint. – David Schwartz May 19 at 0:33
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Besides the tax implications there is something else to consider.

By taking the money from your 401K, and then paying down the mortgage you are moving money from retirement accounts and locking it into home equity.

Don't get me wrong I believe that it can be an important part of retirement planning to be mortgage free by retirement. Others disagree but that isn't the point. You will be moving money that could be invested in stocks, bonds, small companies, large companies, and even international funds all while staying inside the retirement account. Now you will have 130K more money invested in your house, and 130K less in your flexible retirement accounts.

You will have limited options to access the funds in the house. You could sell, you could get a new loan, but those have costs and may even have tax impacts.

This also ignores the complications of taking money from a 401(k) while being employed. But so many people have multiple 401(k)s and IRA accounts it is very possible that others considering this option can use funds in old 401(k)s

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    Yes, but the dollars need adjustment. even in the 12% bracket, it will take $148K to net the $130K to pay off the mortgage. And you all but said, "Liquidity". – JoeTaxpayer May 17 at 20:56
  • So, this raises a good question, I have the other $300K in an IRA that was rolled over from another 401k from a long time ago. Would it be more advantageous to take money from that account rather than my active 401k? – delliottg May 17 at 22:04
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    The flipside of it being tough for you to access the funds you put in your house is that if your pet rhino got loose in a Mercedes dealership the equity in your home would be much easier for a lawyer to recover damages from vs your 401k which is protected even in bankruptcy.. – nvuono May 17 at 22:31
  • @delliottg: What is probably advantageous is to roll over (since you are now over 59 1/2 it should be allowed) from your current employer's 401(k) to your existing IRA. That changes your investment options from the dozen picked by your employer, to practically the entire market. And since IRAs require a lot less paperwork than 401(k) accounts, the expenses charged to you tend to be a lot lower. – Ben Voigt May 18 at 4:16
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This question has a number of variables, but the bulk of the question reduces to one discussion which we've had here a number of times. A guaranteed fixed rate vs a higher variable rate.

You have money (in the 401(k)) which isn't "earning 10%+" but rather, 10% with a standard deviation of 18% or so. It's an important distinction, because even if the 401(k) had a guaranteed 4% available, it would be silly to use money earning 4% to pay off a 2.75% debt.

Even though the numbers look favorable long term, there are anti-debt people who would say that they'd prefer to get their debt to zero regardless of its cost. And others who are ok with carrying a mortgage while working, but are advocates of having no mortgage at retirement. You seem to be on track to having the mortgage paid right when you plan to retire, so that's not the issue.

All that said, I'd suggest you be mindful of your tax bracket.

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With a $24K standard deduction, I am betting that you are in the 22% bracket now, but will probably be in the 12% bracket during retirement. $100K pulled out today would have a tax nearly all at 22%, with perhaps some in the 24% bracket. Let's call it $22K. At retirement time, if your highest bracket is 12%, that's a $12K total hit. You are proposing to throw away $10K.

If you see it as an opportunity to pull some money out of stocks, I'd just rebalance. Move a bit from whatever stock fund to a bond fund within the 401(k) acct. Part of the benefit of the tax deferred retirement acct is the ability to save off the top, at your highest bracket, i.e. marginal rate, but withdraw at the average, lower rate. Now isn't the time to mess that up.

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protected by JoeTaxpayer May 17 at 23:10

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