Real Estate Matters: Is it financially appropriate to borrow from your 401(k) or IRA to pay down mortgage or HELOC?
In the past few weeks, we’ve received numerous emails from our readers asking why we don’t recommend using 401(k) or IRA money to pay off a mortgage or home equity line of credit. Here are two of the letters, along with our thoughts on how to think through your financial choices based on your own personal finances.
Q: My husband turns 65 next month, and his private medical disability payment (around $4,000 per month) will end. We have a monthly mortgage payment of $2,600 and one child with two years left in college. I take home $2,300 a month. Our home is currently worth $1.2 million, is close to downtown Washington, D.C., and a walkable metro stop. The value shouldn’t be going down.
Can we pay off our house by taking out $300,000 from his 401(k)? The 401(k) balance hovers around $900,000 right now. We’re not ready to move right now, so selling isn’t an option. I’ll be working for eight to 10 more years, and we’d have to move several hours away from here to get a price break on our next home purchase.
Q: I read your article titled “Options for funding home renovation.” Why didn’t you suggest or recommend that the homeowner take out a loan from their IRA and pay it back with interest to themselves over 10 years?
A: Thanks to all of our readers who wrote in with similar questions and similar suggestions. We have some strong feelings about when it is financially appropriate to borrow from your future via your 401(k) or IRA and when you should find another way.
Of course, having a substantial retirement account gives you options. If you’ve made saving and investing a priority through your decades of work, your 401(k) should be in fairly good shape for the day you decide to stop working. The stock market has quintupled since its low point in the Great Recession, bringing the total number of millionaires in the U.S. from 6.7 million in 2008 to nearly 22 million, according to the 2021 Global Wealth Report from the Credit Suisse Research Institute.
Unfortunately, it costs more to live. High levels of inflation can eat into your retirement savings quickly, which is why if you can lock in costs (like housing), you’ll have an easier time paying for the lifestyle you want.
But sometimes, life gets in the way of a good retirement plan. In your case, your husband has a medical disability and now that he is turning 65, those payments will end. Will he take Social Security? Assuming his payments are less than the $4,000 you’ve come to depend on, that will still leave your family income short each month.
What can you do now? In general, it’s almost never a good idea to take cash out of your 401k or IRA. In fact, we think this should be the place of last resort for two reasons: First, this is money to fund your retirement, whatever that looks like. If there is another way to get these funds, you should try. Second, taking money from your 401(k) can be expensive. If you take out the $300,000 and then you’ll owe another 25% (likely more) for federal and state taxes (if your state has state income tax). So, you can expect your balance to fall from $900,000 to $500,000 or less. If you’re under 59 1/2 years of age, you’ll pay a 10% penalty on top of taxes.
If you have a 401(k) that permits borrowing and hardship withdrawals, you’ll need to make a decision about whether you’re borrowing those funds (and repaying them with interest, the option our second correspondent raised) or taking a hardship withdrawal, where you are not required to repay the money, but you’ll owe taxes and possibly penalties.