I will retire in 2018 with $210,000 in my 401(k), a $3,000 pension payment and social security benefits; should I use my 401(k) to pay off my $85,000 mortgage, which will cut my living expenses in half?
I’m retiring in October of 2018 at 60 years old. I will have approximately $210,000 in my 401(k). I will be collecting a pension of $3,000 a month, and then social security later when I need more income. I owe $85,000 on a 30-year fixed rate mortgage at 4.3 %. My mortgage payment for my condo is $800. If I didn't have to make that $800 payment every month, my living expenses would be cut in half. (My monthly expenses are currently $1,650). I have $30,000 in savings and no credit card debt. Should I consider paying off my mortgage with my 401(k)?
It really depends upon how you invest your money & what your return expectations, and if you deduct your mortgage payments because you itemize on your tax return. But the real tradeoff is the use of the $85k that you now don't have net of taxes. In other words, how much could you have made on that money and can you make more than the difference in your mortgage rate of 4.3%. Also, I like having the flexibility of having that money compounding tax deferred & away from creditors. Remember also that if you take out the money, it is all taxable all in one year which can push your tax rate higher thus reducing the net for your pension & all other income. Your pension is more than enough to cover the $800 payment. I would lean toward no, but somethings aren't all about money but about comfort & lifestyle. Either way, you live fairly meagerly & are set based upon the facts you provided. So it may just come down to a value judgement, but these are the main pertinent facts you need to answer.
Hope this helps and best of luck, Dan Stewart CFA®
Congratulations on your upcoming retirement! I would agree with John on this one and suggest not paying off your mortgage. We work hard with our clients to get them debt free prior to retirement, but the implications of taking such a large distribution from your 401(k) hardly make this worth it. First, you would need to take much more than $85,000 out of your 401(k) to net $85k after taxes. Second, if you need more monthly income prior to age 70 I would prefer you take that income from your 401(k) balance and allow your Social Security benefits to continue to grow at 8% a year. Third, if you have an emergency or long-term care needs then you will want that money from your 401(k) to help pay expenses. If you are able to do so, then consider paying extra on your mortgage, but keep your nest egg for now.
Sounds like you are in relatively decent shape for retirement, given that your living expenses are more than covered by pension and eventually SSI. Quick question about your $3,000/mo pension - What would happen if the company stopped paying it? Is this a possibility? I know many clients that have retired only to have that ugly surprise come up after the fact.
An after-tax and after-fees rate of return on a balanced portfolio would probably be similar to the cost of your 30-year 4.3% mortgage. Therefore, not much of an investment arbitrage opportunity. Seems also like you could pay down the mortgage a bit with your $30,000 savings. Typically 6 months living expenses is a good rule of thumb to keep on-hand.
You wouldn't want to use 401K funds to pay down the debt, every dollar withdrawn from it is considered taxable income. You may want to defer taking distributions from your 401K until Required Minimum Distributions at age 70.5 kick-in. This gives you a good 10 years to got for capital growth without placing a burden of income on it.
Congratulations on your upcoming retirement. The question you ask is a good one and could be answered several different ways. A few pieces of information you did not include would be, what do you think your life expectancy will be, any major expenses in the next five years, does your budget include cost of medical insurance, does your pension have cost of living adjustments and when do you plan to apply for Social Security.
With what you shared in your question, here is what I would do. Pay off the Mortgage of $85,000 with $20,000 from savings and $65,000 from 401K. Look to do the withdrawals from the 401K in two different years to spread the tax liability. That would leave you with more that a year of expenses in the savings and the $2,200 per month excess cash flow to replenish savings without touching your 401K after paying off the mortgage until you are subject to RMD’s. With the very low interest rates on savings and your low tax rate, this seems to be the better choice.
Something you need to think long and hard about is, what will be your application strategy for your Social Security. Not knowing if you are married, divorced, widowed and what your primary insurance amount (PIA) is it is hard to give advice. What I do know is Social Security will represent between 25% and 40% of retirement income and should not be applied for without a plan structured to get you the maximum benefit. DO NOT rely on the Social Security Employees to guide you thru this process.
While I am a big fan of being debt free, I wouldn't recommend using a one-time 401k withdrawal to pay off your mortgage. You will need to take significantly more that $85,000 out of your 401k to pay the taxes owed and still be left with $85,000 to pay off the mortgage. For example, if you’re in the 33% bracket (combined Federal and state income taxes), you’d need to withdraw $127,500 from your 401k to have $85,000 left after taxes!
You may, however, want to consider accelerating the mortgage pay off by using a series of withdrawals over several years. First, I would not recommend taking a distribution for this purpose in 2018 as you will have worked 10 months this year and, I'd assume, will have a higher tax rate than you would in 2019 and beyond.
Starting in 2019, you may want to consider taking a series of annual distributions and applying the net (post-tax) proceeds to your mortgage. These payments, along with your monthly payments, will pay off your mortgage much, much sooner. However, by spreading it out over several years, you should lower your tax liability (vs. trying to do this all in one year, especially 2018).
Congratulations on your impending retirement. Best of luck!