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.
Another consideration is this: Will the amount of interest you would have paid be MORE than the tax on the money you take out of the 401(k). For example, if your loan is getting small - say less than $50,000 then it is possible that you would pay MORE tax on the amount you withdraw than you would save on the interest.
ReplyDeleteIf you owe more than $50k, you could refinance at a lower rate and get your monthly payments down significantly. Then, you continue to pay what you are paying now and pay the principal down faster.
The look back period for Medicaid is five years. If you deed your home to your children and need Medicaid within five years, you will not be eligible until five years after the transfer. While most parents want to leave a little something to their kids, as taxpayers we need for folks to not give away money that they could have used for their own old age expenses. We're all in this together and everyone who can needs to pay for himself/herself as long as possible. (Ok, that was judgmental!)
Webb,
ReplyDeleteAll good points thanks once again for sharing. I love your judgment because it is so true. And seriously, if Jack can’t afford to pay off his home before retiring without dipping into his 401(k) money perhaps he shouldn’t retire. His main motivation for early retirement is his wife, who hated her manager, retired from nursing last year. It really bugs him that she sits around the house all day while he has to go to work. She is 58. I don’t know exactly what there financial situation is, but if both of them were to work a few years past 62 they may be in better financial shape later on.
They could also put money in a Roth IRA which is easier to bequeath to their heirs than their home and doesn’t have the tax consequences of a pre-tax IRA.