I got an email from a reader yesterday that asked:
“Hello Hank, I’ve been with my company for almost 20 years and I have over $1,000,000 in my 401k. I am 45 years old and I have a house mortgage still of $295,000 for another 13 years paying about $2000 per month. Would it make sense to get out of my mortgage and have that extra $2000 per month to put towards better investments? I plan on working for 10-15 more years before retiring. What do you think? Is that a good idea?” - Neville from Mississippi
Welp, where to start. First of all Neville, GOOD JOB on putting away $1,000,000 in your 401k by 45! That’s tough to do and the first million is always the hardest! Which leads to point #1 (again, take it how you like, I’m not a professional, but this is what I’d do in this situation):
1. The first million is the hardest to get! It’s taken you 25 years to get there! Do you have another 25 to wait? Yes, I know you’ll only be taking out $295,000, but that off of $1,000,000 still knocks you down to $705,000, which isn’t bad at all, but to get back to the power of that $1,000,000 it’s going to take 6 years to get back there, and on top of that, the 705k in15 years investing 15k per year (3% inflation) is going to be a tidy $2,286,545 (click the image to enlarge)
Now that’s not too bad at all, and I’m not knocking it – I hope to be somewhere around there soon too, but think if you leave that $1,000,000 in there for the next 15 years and add 15k per year at 3% inflation you’re looking at $3,077,503 (click the image to enlarge)
Doesn’t that look better? By keeping that money there, you’re banking $790,958 MORE than by taking out the $295,000 that you “thought” you were taking out – but that’s only the beginning –
2. The 401k is set up as a RETIREMENT account – you shouldn’t be dipping into that bucket, that’s what you set it up for, RETIREMENT, not “HOUSE PAYING OFF” – You clearly make enough money to be able to put money away, so why cut the compounding interest short by hacking it into quarters? It’s for retirement, I’d leave it that way!
3. Taxes, taxes, taxes – You’re going to get raked over the coals taking out 401k $ now to pay for your house – not only are you going to have to claim the 401k money as income for the year, that’ll toss you into the highest possible IRS tax bracket at 35%!
Schedule Y-1 — Married Filing Jointly or Qualifying Widow(er)
|If taxable income is over–||But not over–||The tax is:||$0||$15,650||10% of the amount over $0|
|$15,650||$63,700||$1,565.00 plus 15% of the amount over 15,650|
|$63,700||$128,500||$8,772.50 plus 25% of the amount over 63,700|
|$128,500||$195,850||$24,972.50 plus 28% of the amount over 128,500|
|$195,850||$349,700||$43,830.50 plus 33% of the amount over 195,850|
|$349,700||no limit||$94,601.00 plus 35% of the amount over 349,700|
That’s a pretty penny to pay out, especially if you’re used to the 25% bracket you’ve been in. An additional tax on an early distribution is 10% of the taxable amount. The taxable amount is also included in your taxable income. This 10% tax is in addition to regular income taxes. So you’re giving 45% away right there to ol’ Uncle Sam.
4. Your mortgage interest is a tax write off. I don’t know how your mortgage is structured, but I DO know that when your mortgage is paid off, you won’t have that write off.
5. Even if you DID have an extra $2000 to put somewhere each month instead of paying your mortgage, your nest egg is now at $705,000 and even if you put $2k more each month or 24k more per year on top of your 15k, for a total of 39k per year, you’re going to be sucking tailpipe to your $1,000,000 you would have had making regular distributions(click the image):
By putting $39,000 per year into an investment making 10% with 3% inflation, you’re going to bank only $2,920,604, which is $156,899 less than if you would have kept that $1,000,000 in there and made standard 401k donations. If you never wanted to see that 157k extra, I guess it’s no big deal though.
So ultimately I’m saying it’s probably not a great decision. A few things you COULD do though:
1. Ask your plan administrator if you can borrow against your 401k plan; take out a loan to pay off your mortgage, the money would still be working for you, but you’d have to pay it back, but that’d be better than just taking it out –
2. Do you have a ROTH? The tax benefits might be better (I strongly suggest NOT doing this) but you can take out the PRINCIPAL that you have put in to it at no tax consequence, but suggest against it – see response #1 at the top of this page and check out this post on it here.
3. Just contribute $100-$200 more per month to your mortgage – it’s amazing what a few extra dollars per month will do to melt away the balance. Ask Money&Happiness, BuildingEquity, LivingAlmostLarge, or MyMoneyBlog.
If anyone else has any info, feel free to share, but from my perspective, I think you’d be making a bad decision to take 401k money and use it towards your mortgage, but like I said, I’m no professional financial guru.