If the company you work for offers a 401K retirement plan and you’ve been faithfully paying into it on a regular basis, you’ve probably got a tidy sum of money. It’s really tempting to look at that money at 29 or 39 years old and think of all the things you can spend it on. This is especially true when you are facing possible foreclosure on your home mortgage. Should you use those retirement benefits to keep your house or even to pay off your mortgage?
The 401k, a retirement plan offered through many employers, is one of the most valuable assets you have. The money that funds the 401k is tax-advantaged. That means that all the money going into your plan is taken out of your paycheck BEFORE taxes. This means that you pay less in taxes on your take-home pay. This saves you money now. You also do not pay taxes on the earnings on your 401k. Once you retire and start taking out money, you do pay taxes on that 401k money. However, since your tax bracket has probably dropped, you’ll likely pay less in taxes.
The kicker comes if you withdraw money before retirement. You get to pay both taxes and penalties for taking out that money. Before you withdraw money from a 401k, always discuss it with a tax professional, like a CPA!
*** We are not tax professionals and are not giving tax advice. Before you make any financial decisions, we encourage you to contact a tax professional.**
The 401k Mortgage Dilemma
Your house is probably the single largest physical asset you’ll ever own. Tax professionals report that many people consider using their 401k to pay down their mortgage, especially if they are 59-½, and give themselves more money each month. The answer, for most people, is that it does not make sense to pay the taxes and penalties. However, if you are in this situation, talk to a tax professional.
If you are facing foreclosure, you are in a slightly different situation and may be able to use your 401k to keep your home from being foreclosed. Foreclosure puts a huge hit on your credit report, and it may be years until you recover financially. If you are in this position, here are some things to consider.
Using Your 401k To Pay Off Your Mortgage
Your 401k can be used for financial hardships. If you are still employed by the company and are either 59-1/2 or in financial hardship, you can take out enough money to cover the amount to bring your mortgage current plus the amount for taxes and penalties. The IRS charges 10%, so a $5,000 401k hardship withdrawal will cost you $500, plus taxes.
In order to use your 401k, you need to fall into specific categories.
- Do you still work for the company where you have your 401k?
- Yes – go to number 2
- No – go to number 3
- Are you facing foreclosure or are at least 59- ½?
- Yes – You can take out money
- No – You cannot take out money without significant taxes and penalties
- You no longer work for the company or are under 59-½
- Yes – you may take out money but may face taxes and penalties
The often-unrealized penalty for early withdrawal is the decreased earning power that your 401k will have. The money that you withdrew will not be there drawing interest. This may not affect someone early in their career but can financially harm someone at the end of their expected working life.
Another wrinkle to consider is that your 401k is protected from creditors. Your home equity is not 100% protected.
An Alternative to Using a 401k to Pay off A Mortgage
Your 401k may allow you to take out a loan against 50% of the vested account balance. This option requires you to repay the loan within 5 years. This has some advantages, so talk with a tax professional to make certain you can repay the loan and that the advantages work out in your favor.
What If You Use IRA To Pay Off Mortgage?
An IRA is another type of retirement account. Like the 401k, it can be used under certain situations. BUT most tax professionals advise strongly against it. The taxes may eat up most of your withdrawal, the withdrawal may push you into a higher tax bracket, and you may end up owing the IRS money.
Pacific Debt, Inc.
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