Cash out small 401k to help pay down mortgage?

I come to the great minds of the GRM forum for thoughts, comments, and advice.  Here's the critical information.  

My wife and I are in our early 30s.  She stays at home with the kids but she used to be a teacher.  Her state retirement account is at 17k, roughly.  She has been at home for just over 5 years and with another baby on the way, she realistically will plan to for the next 15 years.  I work full time and she has a small part time job with her dad doing some bookkeeping work.  We have no debts apart from our mortgage (just under 70k, 4% interest).  We live comfortably but we don't get to throw a ton extra at our mortgage, which we would like to do.  

Her thoughts regarding her retirement fund:  She doesn't expect to go back to teaching.  It would be more advantageous to us to have that money now and pay down our mortgage.  Once it is paid off, we could put more into our savings/personal retirement/etc.  

My thoughts regarding her retirement fund:  I hate paying taxes but I realize that it is not going to get much larger without doing something.  I would prefer to move it to an IRA that we manage and get it into something more aggressive.

Yes, we understand compound interest.  

Based on the "refund calculator" on the page, she would get roughly 13.5k (just over the total she contributed) back and the rest would be taxes.  My hesitation/question would be whether that 13k that was contributed would count toward our annual income and thus we would have to pay income tax on that as well.  

So, Hive, what are your thoughts regarding this?  I'm right in the middle on it.  The short term gain/long term risk seems right in the middle.  

Nope nope nope nope nope.  

Move it to an IRA and keep it invested.

4% is a reasonably low rate and there is zero reason to pay it down early except for warm fuzzies.  I don't want to go into that whole debate here, but the math says:  pay the minimum, keep extra investment income in higher yield investments.  And definitely don't take out a penalty to do it.  Emotion may dictate otherwise.

Its easy to run the math on the two scenarios you presented above and see which one looks better after 30 years.

No. On top of a 10% penalty, and giving up the tax shelter benefits, you're giving up long term 7% gains for the sake of a low interest low balance loan. It makes no sense. Roll it in to the IRA, that makes sense, but don't take the tax hits and penalties. 

If you're really that concerned about it, find a part time job on the weekends or at night and quit when you hit $13k.

Yeah it makes no sense to cash out a nest egg to pay off a mortgage that will cost at least as much to pay off tomorrow as it would to pay off over the agreed term (remember that inflation could make it effectively cheaper over time). If it was a much nastier form of debt like a credit card or student loan then maybe...

Those guys are correct.

Ever since beginning investing in earnest I've followed the "pay only the minimum on your mortgage and not a penny more" mantra. My original thinking was just that the mortgage rate is lower than my expected return on investments, and while that has proven true over the last decade plus that I've followed that advice, there's another good reason that I recently read. Let me see if I can make it make sense.

Making additional payments on your mortgage reduces the principal balance but does not reduce the ongoing monthly payment requirements. If you stop being able to make additional payments, you still have to make the regular payments. If you stop being able to make those regular payments then you lose your house, no matter how far you've paid down the principal balance. You can end up losing a house to foreclosure despite a decade or more of additional principal payments. It's far better for your financial health to keep the additional mortgage payments in an account that's bearing a return even if it's only equal to the mortgage interest. That way if you run into financial problems you can use those funds to pay your mortgage payment and keep your house. Then in many years if you've built up enough in that account to completely pay off your mortgage and want to do so, you can do so in one fell swoop and, in the same amount of time it would have taken you to pay off the mortgage with additional principal payments, you've done so with far lower risk. There are plenty of short term bond funds or mutual funds with 4%+ long term returns. Heck, I'm getting 3.7% in a savings account right now. (Huntington Money Market)

In your case since you'd be paying a 10% penalty and taxes it makes no sense to withdraw the money and pay down your principal even if you get zero return within the 401k. But I bet you do get a return, and I bet there's a tax free way to move that money to a self directed account. I'm not good enough at the tax stuff to tell you how to do that but I bet some good advice could be gotten from a professional for less than the $3,500 you're estimating in taxes and penalties.

I know how tight money can be at this point in life, BTDT but also a big no on this.  Stop going out to eat, fix the holes in your old socks, etc.  The mortgage hanging over your head is intimidating at times but not worth sacrificing your retirement fund just to pay it down.  How many years will it take off your mortgage?  Won't help today anyway, unless you refinance and rates today make that option stupid.  How much will that money be worth in 30 years?  If anything research things to do with that money to improve the return.  

Don't need to read anything past the title. 

The answer is no. Not a chance.

Just curious of the 7 posters above, have any of you paid off your mortgage?

I know many people that have, and not one of them has said "well that was dumb". I agree it does not make sense math wise most times (the penalty here is the big one for me), but going from owing just under $70k to mid $50k can be good for your mental health. Lot's of talk of 30 year results in a world where Tomorrow is not guaranteed

Don't do it.  You pay a penalty.  And the amount is also added to  your annual income.  And max out your 401k for your whole career.   Nothing is better than time for compound interest to work.

Although I've always made additional principle payments and I paid off my mortgage last May when the balance got down to 27K by selling stocks efficiently (no penalty) I totally agree with dculbersdon, the hard math sez' I didn't make the best financial decision...I knowingly purchased ProDarwin's "warm fuzzies" which I could afford to do.

I believe your situation is very different as you'd be hit with penalties and it appears you don't yet have the financial reserves required to ignore the hard math.

The likelihood that inflation drops back to nominal levels anytime soon is very low so, as GameboyRMH pointed out, that 70K is going to shrink quickly in relative terms all on its own.

Do as I say not as I do ...keep the loan and only make minimal payments until you've got no other loans at higher interest rates and you've got a good cash reserve built up.

In reply to Steve_Jones :

I have. But while I'm in the "pay off a mortgage ASAP" camp, I also agree with the "not with your 401k" camp above. 

While the market is wonky right now, this is not the first time and probably won't be the last.  As a point of comparison, one line item in my 401K statement is the roll-over balance I transferred from my last company some 20 years ago. That line balance has more than tripled since, even after going through a few sizable market downturns - when I ignored the doomsayers and did nothing but "hold". 

I paid off my mortgage early, but after maxing out my 401k and had built up a decent emergency fund. I can say that having a paid-off house gives one a certain level of comfort that is hard to put a value on.  And it definitely allows one to build up reserve funds and additional retirement accounts quickly. 

jmabarone said:

Her thoughts regarding her retirement fund:  She doesn't expect to go back to teaching.  It would be more advantageous to us to have that money now and pay down our mortgage.  Once it is paid off, we could put more into our savings/personal retirement/etc. 

This is just taking money out of a personal retirement account, taking a penalty and taxable income hit on it, sitting on it in the mortgage for a a period of time while having zero immediate effect on monthly finances, all so you can slowly feed it back into things like personal retirement accounts later.

Any extra money you 'throw at your mortgage' is basically just a low risk, but low reward, investment account. Your effective ROI is the interest rate on your loan. That same money in an IRA has a significantly greater reward potential, but at somewhat greater risk. This is where it's good to look at your retirement goals and what is going to be required to achieve them, vs your risk tolerance. But even if paying off early meets both your risk tolerance and retirement planning needs, doing it by pulling early from retirement accounts (heavily penalized and taxed) is one of the worst possible way to do it.

It's not a "short term gain/long term risk". The only gain is a medium term warm/fuzzy for the duration of difference between mortgage payoff dates. Everything else (short/long term) is a loss or likely loss.

Ian F (Forum Supporter) said:

In reply to Steve_Jones :

I paid off my mortgage early, but after maxing out my 401k and had built up a decent emergency fund. I can say that having a paid-off house gives one a certain level of comfort that is hard to put a value on.  And it definitely allows one to build up reserve funds and additional retirement accounts quickly. 

That's exactly where her mindset is.  But, we aren't going to pay it off entirely so what's the point?  

I knew the answer going in, but just wanted to get some outside thoughts.  Glad to see there are a few that have similar thoughts on the concept.  

Thanks guys!  

As the sole provider for a growing family, I could maybe see some logic here if your job was unstable and you could fully pay off the entire remaining balance of the mortgage. That would reduce your monthly cash flow needs and add security to weather the potential loss of your income.

But with the given info there are multiple less-than-ideal concepts stacked on top of each other (1- paying off 4% mortgage early 2- with retirement funds 3- not paying the entire remaining balance) and no real tangible benefit, which leaves a big ol bag of 'nope'.

Steve_Jones said:

Just curious of the 7 posters above, have any of you paid off your mortgage?

I know many people that have, and not one of them has said "well that was dumb". I agree it does not make sense math wise most times (the penalty here is the big one for me), but going from owing just under $70k to mid $50k can be good for your mental health. Lot's of talk of 30 year results in a world where Tomorrow is not guaranteed

But he's not talking about paying off his mortgage. He's talking about paying off a small portion of it. It would be a different discussion if he was talking about paying it off entirely.

I made additional principal payments when I was young. I do regret those - if I had invested them instead it would have been worth way more than the check I got when I sold that house.

STM317 said:

As the sole provider for a growing family, I could maybe see some logic here if your job was unstable and you could fully pay off the entire remaining balance of the mortgage. That would reduce your monthly cash flow needs and add security to weather the potential loss of your income.

But with the given info there are multiple less-than-ideal concepts stacked on top of each other (1- paying off 4% mortgage early 2- with retirement funds 3- not paying the entire remaining balance) and no real tangible benefit, which leaves a big ol bag of 'nope'.

This. I disagree that paying off a mortgage is always a poor decision. The freedom and flexibility it provides when you can do that is great. Risking your future to do so is not a good idea. Pay extra when you can, do not cash out retirement funds for a small dent. 

Ian F (Forum Supporter) said:

In reply to Steve_Jones :

I have. But while I'm in the "pay off a mortgage ASAP" camp, I also agree with the "not with your 401k" camp above. 

While the market is wonky right now, this is not the first time and probably won't be the last.  As a point of comparison, one line item in my 401K statement is the roll-over balance I transferred from my last company some 20 years ago. That line balance has more than tripled since, even after going through a few sizable market downturns - when I ignored the doomsayers and did nothing but "hold". 

I paid off my mortgage early, but after maxing out my 401k and had built up a decent emergency fund. I can say that having a paid-off house gives one a certain level of comfort that is hard to put a value on.  And it definitely allows one to build up reserve funds and additional retirement accounts quickly. 

All of this. The ONLY way I could see this being a not dumb move would be if the house mortgage was a high interest loan. I worked with a guy that closed out a small IRA to pay down and refinance from a 7.5% loan to a 3.75% loan and go from a 30 year (25 left) to a 15 year. The savings in interest between them was worth it in his case. 

In reply to Steve_Jones :

Tomorrow is never guaranteed. The best you can do is plan the best you can, enjoy today and hope that tomorrow allows you to do the same. 

When I refinanced  our mortgage several years ago I left the monthly payment the same. The delta went towards the principal and shortened the term to 18 years. So, a few years after retirement my house was paid for and we kept a nice chunk of cash. That was nice to have at that point in life. I would never take 401K funds to pay down the mortgage though.Leavethat alone and you'll appreciate it in your older years.

One financial tool that is important to remember, the rule of 72.

Take 72 divided by your interest rate, I  think you said 4%... 72 divided by 4 is 18.  So every 18 years your money will double.  In 18 years your $17K is now $34K, in 36 years $68K.

In other words, leave it where it is OR move it to another protected investment like an IRA.

Instead of withdrawing everything from the 401k, does her plan allow her to borrow from it? Typically you can borrow up to 50% with no penalty and all of the "interest" she pays would actually go back into her 401k. Doing this would only get you $8500 to put towards your mortgage instead of the $13500 you would get by shutting down the account but this way you're not losing $3500 in the process of shutting the 401k.

The only downside to this would be that you would now have an additional loan payment every month, over 5 years, that would be about $150 a month.

Another thought I had about paying down your mortgage instead of investing the cash is that most investment professionals recommend owning a mix of stocks and bonds, not 100% stocks. Over the last few years the yield on bonds has been ridiculously so there hasn't been much point in owning them. Paying down a 4% mortgage kind of accomplishes the same return as a 4% bond, so you could substitute additional mortgage principal payments for bond purchases. But taking penalties on a 401k withdrawal to do this is not a good idea.

I'm in the debt free camp.  But in your case, cashing out your 401k will NOT be enough to retire the mortgage, so don't do it.  

Paying down your mortgage is still the best way to go when you can add a bit towards principle every month.  People will tell you to invest, but when you invest you are making a small yield on a small amount, so not much cash being generated. 

Look at your mortgage amortization table.  When you are 50% through the mortgage term, say 15 years out of 30, you still owe way more than half of the original principle.  Payment 180 of 360 will still be 60% interest.  You cannot out earn that!

In summary, keep the 401k intact.  Pay extra on the mortgage only when you can and after you have an emergency fund.

trucke said:

Look at your mortgage amortization table.  When you are 50% through the mortgage term, say 15 years out of 30, you still owe way more than half of the original principle.  Payment 180 of 360 will still be 60% interest.  You cannot out earn that!

Most retirement accounts absolutely out-earn that.  Shocking numbers don't tell the whole story.  Do the math a few different ways and look at what the best investment strategy is.  Unless you have really low market returns and a really high mortgage interest rate, paying the mortgage is, mathematically, not the best option.

Yes there is a mental health/warm fuzzy/risk averse angle to doing so.