Using Retirement Money to Pay Off the Mortgage

Aug 11, 2009 — -- For many folks, the urge to pay off a mortgage seems to strike when the layoff notice arrives.

That's my conclusion based on e-mails I've received during the current recession. More than once, readers have asked whether it's a good idea to take a lump sum from their retirement nest egg and make a giant payment to wipe out their mortgage balance.

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The thinking is that their post-layoff life will be easier if they can live mortgage-free. Of course, they are correct. But that doesn't mean paying off a mortgage in full after a job loss is always a good idea, even if you've got the funds available to do so.

In fact, in most cases, I would say it's a bad idea.

Consider the example below.

Question: My wife just received a 60-day advance layoff notice. She will be 59½ when she leaves. My question is: Would it be wiser to use a portion of her 401(k) to pay off our $100,000 mortgage balance (30 yrs, 4.75 percent), or leave it all in her 401(k) to continue drawing interest (currently 3.64 percent), and continue paying mortgage on a single income?

-- D.P., Decatur, Ala.

Answer: For the time being, D.P., I would say it's best to leave the money in your wife's 401(k) account and continue making monthly payments.

The main reason that I say this is that a $100,000 lump sum withdrawal from her 401(k) is going to trigger a big tax bill at a particularly bad time. Even though your wife is old enough to avoid the 10 percent early withdrawal penalty, she would still owe federal and state income taxes on any amount she takes from her 401(k) account.