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I know the number one rule is to not use retirement money early to pay off a mortgage. But i truly hate the feeling of having this mortgage. And i really want to pay it off.

I understand 401k money is taxed when you pull some out. I also understand there are penalties involved in pulling money out early. But i do have some questions.

Assume I needed 150k from my 401k to pay off my mortgage. Lets say my salary per year at my job is 150k a year. Does this mean come tax time (say for 2022) i would be reporting that i made in actuality 300k due to pulling 150k from my 401k and plus my regular salary?

I just would like to know how that works as ive never pulled out of my 401k. For background Im in my early 40s with close to 1 million in my 401k.

I would like to pull out 150k from my current fidelity 401k (may need to pull 200k due to taxes etc). So basically my question is how does this all work during tax time am i reporting i made 300k?

I do understand this is not the ideal solution etc etc and i understand the ramifications of losing compounded gains / interest over time. I also understand the money is taxed and their are fees for early withdrawals please focus on my question no need for lecturing.

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    IMO if your annual salary is the same as the amount you owe on the mortgage then just pay extra until it's gone. Using your numbers, if you can stand to live off 100k instead of the full 150k, then your (probably) 30-year mortgage is done with in 3 years.
    – Nosjack
    Commented Feb 3, 2022 at 18:35
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    I've tagged this as united-states since you mention 401k. If this isn't correct please edit or comment.
    – Vicky
    Commented Feb 3, 2022 at 19:08

3 Answers 3

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Does this mean come tax time (say for 2022) i would be reporting that i made in actuality 300k due to pulling 150k from my 401k and plus my regular salary?

Yes.

So basically my question is how does this all work during tax time am i reporting i made 300k

Yes, but not only that. For the money you pulled from 401k you'll have an extra 10% early withdrawal penalty. So basically your taxes will be calculated as if you earned $300K, and then on top of what comes out of that calculation you'll have an extra $15K tax liability added.

Additional considerations

You asked not to lecture you and I'm not trying to, but in the list of things you said you are aware of I didn't see the following:

  • Can you even make the withdrawals? Not all 401k plans allow early withdrawals to their participants, especially those still employed by the sponsoring company. You may not be able to do what you want because your plan doesn't allow that.

  • Have you considered taking a loan out of your 401k? It will allow you to get rid of the mortgage and debt (you'll technically owe the money to "yourself" now), and you can still replenish the retirement funds if you have money available to repay the loan. This may also depend on what the plan allows.

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  • I'd argue that having the 401k loan is worse than the mortgage, since the loan would come due if they leave the company, unlike the mortgage which doesn't care about their employment status.
    – chepner
    Commented Feb 3, 2022 at 18:41
  • @chepner true, but the OP is fine with 401k distribution, so in that case that would be the exact same effect. However by having a loan the OP can defer it, and potentially reduce the impact by repaying some of it.
    – littleadv
    Commented Feb 3, 2022 at 19:26
  • The distribution is final, though: it doesn't have to be repaid immediately (or very soon) if they leave their job.
    – chepner
    Commented Feb 3, 2022 at 19:42
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    Yes. The 'but' is that the 401(k) loan is limited to $50K. (did this change and escape my attention?) Otherwise loan is always better than withdrawal. Commented Feb 3, 2022 at 20:36
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    I don't think that has changed
    – littleadv
    Commented Feb 3, 2022 at 22:39
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Other answers have addressed the qualitative aspect of the question.

This answer is to supplement that with quantitative analysis.

First, let's take a look at income tax with $150,000 of annual income, assuming married filing jointly filing status, and 2021 tax brackets:

Tax breakdown with $150,000 annual income (clickable link to an excellent visualization tool)

  • Gross Income: $150,000
  • Standard Deduction: $25,100
  • Taxable Income: $124,900
  • Total Tax: $18,975
  • Income Kept: $131,025

My rough estimation shows that a 401(k) distribution of around $230,000 is required to produce $150,000 of after-tax and after-penalty money - and this is assuming 0% state income tax.

Tax breakdown with $380,000 annual income - $150,000 salary + $230,000 distribution from 401(k) (click on the link for a picture worth a 1000 words)

  • Gross Income: $380,000
  • Standard Deduction: $25,100
  • Taxable Income: $354,900
  • Total Tax: $75,222
  • Income Kept - before penalty: $304,778
  • 10% early distribution penalty: $23,000
  • Income Kept: $281,778
  • Extra after-tax and after-penalty income: $150,753

Taking $230,000 out of 401(k) is a very expensive way to pay off $150,000 left on a mortgage.

When state tax is accounted for, an even larger distribution is required!

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Yes, the distribution is taxed as income. There are significant disadvantages:

  1. Reduced retirement assets (that would otherwise grow tax-deferred, so a double-whammy)
  2. A large tax bill from the distribution
  3. Loss of the mortgage interest deduction, so an even higher tax bill

We could also talk about a 401k loan vs a distribution and penalty.

I won't lecture OP, who is already aware, but instead warn those browsing this question and answer: the 401k is an advantageous vehicle for saving for a comfortable retirement. It's an absolutely horrible way for a 40-something-year-old to pay off a mortgage while still working and earning because you get none of the tax advantages available to homeowners with mortgages, you maximize your current taxes and incur penalties, all while reducing your future retirement funds. Borrowing from a 401k is less sucky, but still unwise if you can afford the mortgage.

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  • The fact that a 40ish person has $1M in their 401(k) implies they are getting a match (not for sure, but likely). I'd suggest no attempt at withdrawing, but reduce new deposits to just the matched amount. A withdrawal typically disqualifies matching for a time anyway. Commented Feb 4, 2022 at 14:38

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