No Matter The Season, I'll Get You Through

You Should Not Use 401(k) Funds to Pay A Mortgage

Using retirement funds to pay off a mortgage is not always a good idea.
Please Share!
Share on facebook
Facebook
Share on twitter
Twitter
Share on linkedin
LinkedIn
Share on email
Email
When it comes to your money, be careful who you listen to. Taking advice from an uninformed person can cost you dearly.

We call it “the brother-in-law” effect. Most families have a brother-in-law who likes to think he knows everything, and he’s more than happy to share his wealth of knowledge. Trouble is, most of what he knows is wrong. What would your brother-in-law say about using retirement funds to pay off a mortgage?  A 60-year-old woman was told that she could use her 401(k) or IRA funds to pay off her mortgage and never have to pay any taxes, or not until she sold her home. This, says The Washington Post’s article “Sorry, you can’t escape income taxes by using 401(k) funds to pay off your mortgage,” is a perfect example of someone giving really, seriously, bad information.

Let’s start by clarifying how 401(k) and IRA plans work. With a traditional 401(k), contributions are made on a pretax basis. Income taxes are then due on both contributions and earnings, when distributions are taken. There is a 10% tax penalty, if the money is taken out before the account owner reaches age 59½.

Depending on the person’s income, contributions to a traditional IRA may be deductible from taxable income. Income taxes aren’t due, until the money is withdrawn. With a Roth 401(k), contributions are made after taxes have been paid, so there are no income taxes due when money is withdrawn.

Is there a loophole for mortgages? The short answer is no.

There are relief provisions for the 10% additional tax, but since this person is past the 59.5 threshold, that is not an issue in the situation described above. Distributions from a Roth IRA or a Roth 401(k) are different, but even then, there wouldn’t be anything special about the distributions being used to pay a mortgage.

While you might not incur a penalty because of the age issue, any distributions would be subject to income tax. If the money has already been taken out of the IRA, the woman may have a 60-day window to put the money back in the account without being taxed—unless she has already used this rollover treatment within the last 365 days.

There is a special provision for first-time home buyers under 59.5 to use IRA money to avoid the 10% early withdrawal penalty, but that doesn’t apply here.

Using retirement funds to pay off or pay down a mortgage requires a careful analysis of the costs, in terms of penalties, taxes, and future costs.

One potentially compelling reason would be a senior who has more than enough money saved for retirement and simply wishes to retire debt-free. Another would be a homeowner who is in a low-income tax bracket but will also be taking the standard deduction each year. If that person is paying interest on a 4.5 percent mortgage without receiving any tax benefits, then it could make sense to withdraw money from an IRA and pay off the mortgage. However, the withdrawal will be treated as income, so that needs to be part of the analysis.

Generally speaking, the best use for retirement money is retirement. Keeping accounts intact for use later in life while enjoying tax-deferred growth is the real reason for these accounts.  If you need advice on retirement and taxes, speak to an estate planning attorney.

Reference: The Washington Post (October 30, 2019) “Sorry, you can’t escape income taxes by using 401(k) funds to pay off your mortgage”

 

Get All The Updates