Should I clean my 401 (k) to pay off my mortgage?


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The Credible Money Coach answers a reader’s question about the tax implications of cleaning up a 401 (k). (Credible)

Dear credible money coach,

I am considering putting everything I have saved into a 401 (k). Can I withdraw everything at once? I want to use some of this to pay off my mortgage faster now that I’m over 59½ years old. I still plan to work longer. How does this affect me from a tax point of view? – Shana

Thanks for your question, Shana! Depending on the terms and conditions your employer has set on your retirement account, it is possible for you to take every dollar out of your 401 (k) as a lump sum.

While being mortgage-free before retirement is a good idea, I’m not sure if using up a retirement account is the best way to get a mortgage off. Here’s why.

You could suffer a significant tax collapse

A 401 (k) is a tax-privileged retirement account. Your contributions are not taxed until you deposit the funds into the account. But any amount you withdraw is generally subject to federal income tax and possibly state income tax depending on where you live. This applies regardless of whether you make a withdrawal at 29, 59 or 79.

If you take money out of a 401 (k) before you are 59½ years old, that amount is usually subject to a 10% penalty in addition to regular tax, although there are some exceptions. Since you are over 59½ years old, you will not pay this penalty, but your payout will almost certainly be taxed. And of course, the larger the amount you withdraw, the higher the tax bill will be.

The tax rate applied to the withdrawal is based on your total income for the year you make the withdrawal and this is where the tax impact can become even greater. Without knowing your annual income or how much you have in your 401 (k), I cannot give you an estimate of what your tax bill might be. But here’s an example of how a large withdrawal could affect your tax burden.

Let’s say your annual income is typically $ 75,000 a year, you sign up as single and take the standard deduction. Your income will likely be subject to a federal tax rate of 22% and your federal tax bill will be approximately $ 9,500. But if your 401 (k) withdrawal doubles your annual income to $ 150,000 and nothing else changes, your new tax rate will be 24% and your tax bill will increase to more than $ 27,000.

Further considerations

Shana, you also don’t say if this 401 (k) is your only retirement plan or if you have money in other accounts like an IRA or another 401 (k) employer. If this is your only retirement account, I strongly warn you not to empty it completely, especially since it sounds like you are nearing your retirement age.

Even if you intend to keep working after retirement, it is important to have savings for your golden years. While you are withdrawing all of your money and using it to pay off your mortgage, you save the interest you would otherwise have paid on that home loan, it also costs you all of the income that you could get from putting the money in your 401 (k). This loss could potentially exceed the interest savings you could hope for from a paid off mortgage.

Other ways to pay off your mortgage faster

If your goal is to get your mortgage off faster and save money in the process, refinancing your existing mortgage may be a good option for you. Although interest rates have risen in the past few months, they are still relatively low. If your mortgage is over five years old, you can get a much lower interest rate with a refinance now.

If you also choose a shorter term – say 15 instead of 30 years – and make additional payments, you will pay off your mortgage even faster.

Another option could be 401 (k) loanif your employer allows it. You can borrow against your 401 (k) to pay off your mortgage and then repay yourself at a likely much lower interest rate. In this way you can pay off your house, save interest and protect your retirement provision.

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About the author: Laura Adams is a personal finance and small business expert, award-winning writer, and host of Money girl, a premier weekly audio podcast and blog. She is often quoted in the national media and millions of readers and listeners benefit from her practical financial advice. Laura’s mission is to help consumers lead richer lives through her speeches, speaking engagement, and lobbying. She has an MBA from the University of Florida and lives in Vero Beach, Florida. Follow her up, Instagram, Facebook, Twitter, and LinkedIn.

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