I turn 59 1/2 this month and plan on retiring when I’m 62. You’ve told me in the past I can access my 401(k) monies without incurring an IRS penalty at age 59 1/2. I would like to withdraw my money now and use it to pay off my mortgage. I want to be 100% debt free; I hate paying interest plus, I’ve always heard you should be mortgage free when you retire. Once retired, I plan on deeding my home to my children, so it doesn’t go to the nursing home. Is this a good plan?You are correct at age 59 1/2 our 401(k) plan does allow employees to access their monies without incurring an IRS penalty.
Is it a good idea?
It is if you plan on rolling your money into another qualified IRA. Our company’s 401(k) plan offers a limited selection of investment choices plus, our plan fees are excessive. Please see my post 401(k) fees rant. I recommend you consult with an independent fee-only financial planner for advice on setting up a self-directed IRA consisting of low-cost investments.
If you choose not roll your money into another qualified IRA, and use this money to pay off your mortgage any money you withdraw will be added to your 2010 income for tax purposes. This will push you into a higher tax bracket resulting in a hefty Federal and State tax bill. Also, you will lose any future interest payment tax deductions. If you really want to use this money to pay off your mortgage I’d wait until after you are retired and no longer collecting a paycheck. Instead, make extra payments against your mortgage now while you are still working. You'll also still benefit from tax deductions on the mortgage interest you pay.
Longevity risk is the biggest financial risk facing retirees today.
If you use your 401(k) monies to pay off your mortgage are you sure you will have enough other monies (savings, social security, pensions, etc.) to sustain your lifestyle for your entire retirement? Paying less interest is a good thing, but not if you can put your money to a more productive use. You tell me your fixed interest expense is 5.4%. Look at the relative rate of return on your 401(k) vs. your interest rate especially now when the stock market is on the upswing. I’d hate to see you miss out on this up tick.
Once you are retired and are sure you have enough money to sustain your retirement, go ahead and use your 401(k) savings to pay off your mortgage. I've heard Clark Howard recommend callers pay off their mortgage even if the numbers don’t make complete sense. He says it is best for risk adverse investors like you Jack to own their home free and clear than lose sleep worrying about future market losses.
As to deeding your home to your children, check with a lawyer; legislation has been passed closing this loophole. There is now a “penalty period” (a period of disqualification from Medicaid). Simply defined if you transfer your home to your children, you will be disqualified from receiving Medicare benefits when needed until the penalty period has been met.