Don't use retirement funds to pay off mortgage

December 17, 2010

Determine whether to use money from a 401(k) account to pay a mortgage.

A: We discourage clients from taking any early withdrawals from retirement accounts, because it is very expensive to do so and it will reverse the retirement savings process. The combination of the income tax and early withdrawal penalty could erode up to half of any withdrawal.

Moreover, you may not even be able to withdraw money from your 401(k) at work to pay off your mortgage because you are only allowed to withdraw money from a 401(k) plan for certain hardships outlined in the plan. If you are allowed to withdraw the money, then you would have to pay income tax on the withdrawal. Depending on how much you withdraw and how much other income you have, the tax could range from 10% to 35%. You also would have to pay an additional 10% penalty if you are under age 59 1/2.

In light of these various taxes and restrictions, avoid using retirement account money to pay off your mortgage if at all possible.

Send your money management questions to medec@advanstar.com (please include your regular postal address). Answers to our readers' questions were provided by Rial Moulton, JD, CFP, CPA/PFS, cofounder of Retirement & Tax Planning Specialists, Inc. in Spokane, Washington.