Before you decide to loan yourself some money out of your 401K to pay off your mortgage, consider one Abbott Lab investment advisor’s perspective. Depending where you are in your journey towards retirement, cashing in part of your 401K in order to pay off your mortgage may be a great strategy to lower your future loan expenses, but at what cost?
Borrowing from you 401(k) can be an expedient and low-cost way to pay off your mortgage and receive some added income for home improvements and other expenses. However, if you plan on leaving your job or see possible layoffs in the future, you will need to pay back the balance of your loan immediately after you leave the job. Or, as many plans offer, you may have a grace period of 60 or 90 days to arrange plan-loan repayment after leaving work.
If you can’t pay it back, it will be considered a taxable distribution. And, If you are under the age of 59 ½, you will also incur an early withdrawal penalty of 10%. The good news, of course, is that even with the higher rate, any delay in payment will not affect your credit rating. If you can set up a short-term payback schedule, you will also have little impact on your overall progress.
You should also consider the true cost of withdrawing from your retirement account. If your contributions were all pre-tax, your withdrawal will be subject to federal, state and local taxes. Depending on your age, your estimated taxes could be as high as 40% or more on your retirement distribution. If your 401K is invested in a portfolio that has the potential to return more than the cost of your mortgage over its remaining years, then paying off your mortgage will more than likely work to your detriment.
Think about the age you will be retiring. Is such a transaction realistic? Depending on how much you plan to withdraw, the closer you are to age 65, the more significant the reduction in your future standard of living. Of course, you could divert your mortgage payments into your retirement fund as long as you have the discipline to direct the extra savings back into your 401K before you reach retirement age. However, there are contribution limits that may be lower than your annual mortgage payments.
For more information about sound strategies and realistic expectations for borrowing against your 401K as you plan for a confident financial future, visit us at mooneylyons.com.