Is it smart to pay off my mortgage with money from my 401(k) and save $800 more per month? The mortgage balance is $60,000.

– Robert

Many people consider paying off their mortgage to be a “must do” before retiring. While there are benefits to this approach, there are also tradeoffs, so it’s good that you’re considering your options. Ultimately, there’s no hard line in the sand on this one. Your mortgage interest rate and the expected rate of return on your 401(k) investments are the two main pieces of information to consider. However, your attitude toward debt and security can also play a strong role in the decision.

A financial advisor can help you with questions like this one and offer a range of other financial services. Connect with an advisor today.

Using 401(k) Money to Pay Off a Mortgage

To set the stage, let’s talk about the fact that you’d be using money from a 401(k). This makes the analysis a little different than if you had cash in a brokerage or savings account. That’s because you’ll pay income tax on the distribution.

Ensure you review the tax rate applicable to your current tax bracket. You will need to withdraw enough money to cover both the tax bill and the $60,000 mortgage balance. For example, if the entire withdrawal falls within the 24% tax bracket and you do not pay state income tax, you can calculate the required withdrawal amount as follows:

Divide $60,000 by (1 – tax rate): $60,000 / 0.76 = $78,947.37.

This is the amount you would need to withdraw to cover both the taxes and the mortgage balance. Keep in mind that you’ll face a 10% tax penalty on the withdrawal if you’re under 59 ½ years old. (And if you need help calculating your potential tax liability on transactions like this one, consider working with a financial advisor.)

Interest Rate vs. Return of Return

A couple reviews their bills together to determine whether to pull money from their 401(k)s to pay off their mortgage.

Next, compare your mortgage rate vs. the expected rate of return of your 401(k). If your mortgage rate is less than your expected rate of return, that indicates you may want to leave the money in your 401(k). The greater the difference, the easier the decision.

For example, if you have a 4% mortgage rate but believe that your 401(k) balance will grow by 6% or 7% per year, it would likely be better to leave the money in your account and keep paying the mortgage. On the other hand, if you’re a conservative investor and think 5% is a more likely rate of return but have a mortgage rate of 6%, it’s probably better to pay off the mortgage.

While this forms the basis of how to answer your question, this alone shouldn’t necessarily drive your decision. Remember, investment returns can be volatile, while mortgage rates are normally fixed. If the difference between the two is small, it may still make sense to pay off your mortgage, even if the interest rate is lower than your expected return on investment. For example, saving a guaranteed 4% by paying off your mortgage might feel better than investing with the hope of achieving a 5% return.

(Remember, a financial advisor can help you evaluate and answer financial planning questions like whether to use 401(k) funds to pay off a mortgage.)

Carrying Debt Into Retirement

There can also be a psychological cost associated with carrying debt, especially in retirement. It may be small for some people, particularly if their mortgage rate is low. For others, carrying debt into retirement can feel like a heavy load. The exact cost for you will depend on your personal attitude toward debt.

I think this is an important element of your decision. To frame it all together, go back to that tradeoff between your interest rate and expected rate of return.

If that difference is large, it might be easier to make a decision regardless of your personal perspective on the decision. The smaller that difference, your personal perspective might become increasingly more important.

Consider these two examples:

Suppose you have a 2% mortgage rate, but a reasonable belief that you might earn 9% on average from your 401(k) investments.
Now, assume you have a 4% mortgage rate, but expect to earn just 5% on your investments.

Only in rare circumstances would it make sense to pull money out of your investments to pay for your mortgage in the first example, regardless of your personal psychology. In the second example, the math alone says to pay off your mortgage but I don’t think it’s that clear-cut for everyone.

Instead, if you have a strong inclination to pay off your mortgage, ask yourself “Is it worth giving up 1% to be done with this mortgage?” (If you need financial guidance, connect with a fiduciary financial advisor today.)

Next Steps

A couple reviews their mortgage balance and discusses whether to use 401(k) funds to pay it off.

Figure out how much you would need to withdraw to pay off your mortgage based on your tax rate. Then, compare your mortgage rate against your expected investment return. If your mortgage rate is lower, I would suggest keeping the money invested. However, consider your attitude toward your mortgage debt. If the relief of paying off your mortgage is substantial, then it could still be a good decision even if your mortgage rate is lower.

Tips for Finding a Financial Advisor

A lot can go into finding a financial advisor to hire. Not only will you need to assess your own financial needs and goals, you’ll also want to evaluate potential advisors’ credentials, services, fee structures, personal style, among other considerations. Luckily, we’ve compiled a comprehensive guide to walk you through each step in the process of finding and choosing a financial advisor.
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.

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