Benefits of 401(k) exceed mortgage payoff
A reader asks: “My current 401(k) balance is about the same as my mortgage balance. I am 45. Would it make sense to pay off the mortgage with the 401(k)?”
Bad idea! Looking to retirement, your objective should be to accumulate a 401(k) nest egg of financial assets as large as possible and pay off your mortgage as soon as possible. You should pursue these objectives independently, not sacrifice one to obtain the other. That would be a loser, for many reasons.
• Early withdrawal costs: Funds withdrawn from a 401(k) before age 591⁄2 trigger tax payments on the amount withdrawn plus a 10 percent early-withdrawal penalty. While there are exceptions to the penalty, paying off a mortgage balance is not one of them. That means paying off a mortgage balance with a 401(k) balance of the same amount would generate a sizeable cash outflow.
• Earnings opportunity loss on the existing 401(k) balance: An even larger loss from liquidating your 401(k) is the future earnings on the funds withdrawn. These earnings accumulate tax- free until you are 70, and at that point you pay taxes only on the amounts withdrawn at your tax bracket at that time, which could be a lot lower than it is now.
• Possible earnings opportunity loss on new contributions: If your intention is to abandon your 401(k) after draining it, given that you are many years from retirement, the largest loss would be the tax-deferred income you could contribute plus the tax- deferred earnings on those contributions. Your objective should be to contribute as much as possible.