Do you have money saved up for retirement? Have you ever thought about taking those funds out and using them to pay down the mortgage? You think it’s a good idea because you’re getting rid of your debt, but is it a wise move when you look at the long term results?
I have heard this question quite a lot lately – “I have some pretty good money saved up for my retirement, but we still owe on our house and will have to continue making payments for another 10 years. Would it be a good idea for me to take the money out and pay off my mortgage?”
This question keeps coming up because people are beginning to realize how stupid debt really is. It’s borrowed money that often costs twice the amount to pay back. Plus, in the event of an emergency, it’s possible that the loan payments can’t be made. All of the sudden you might be saying, “Bye-bye house” as the bank takes back what’s rightfully theirs. If you owned your house in full, there would be no need to worry.
What Is the Downside of Pulling Money Out of Your Investments?
There are downsides to nearly every decision, and this one has a few:
- Penalties – If you’ll be removing your money from a retirement account (like a 401(k) or a Roth IRA) and you are not of a certain age (typically 59 1/2 years old), you will be penalized for your withdrawal (normally, this is 10%).
- Capital Gains – Yes, you’ll have to pay them sooner or later, but just be aware that once you remove your money from your investment accounts, your earnings are realized and you’ll have to pay taxes on those gains.
- Lack of Retirement Funds – What if you pulled every last penny out of your retirement funds to pay off your house? You now have absolutely no liquid cash for retirement – it’s all stuck in your house. When you near your retirement years, liquidity is very important, so be cautious before making any hasty decisions.
What are the Benefits to Paying Off Your House?
The benefits are actually very simple:
- Save Money on Interest – By paying down your house early, you’ll save yourself a boat-load of money because you didn’t have to make those monthly interest payments on the remainder of the loan!
- Live in Peace – When money is tight and you’re not sure you can make the mortgage payment from month to month, that’s pretty stressful. Miss enough payments and you’ll be on the street. If you could just own the house in full, life would be so much more peaceful.
What Would I Do?
So if I had the choice, what would I do in this situation? You all know how much I hate debt, and you might think that I’ll tell you to do whatever’s necessary to pay it off, but I’m not heading down that road this time. As you can see from the variables listed above, there are many factors that play into this decision and every situation is a little different, so there is absolutely no correct standard answer here. Mainly, my answer depends on the potential penalty for removing the funds.
The 10% Penalty for Early Withdrawal
If my money was coming from a 401(k), 403(b), or a Roth IRA, I would absolutely leave the money in the account. There’s just no sense in taking a 10% penalty to pay for a 4% interest loan.
No Penalty on the Withdrawal
If there was no penalty on the withdrawal from my investment account, I’d most certainly use it to pay off the debt, but I would make sure to have enough money for taxes.
Let’s say you put $50,000 into your investment account over the years, and now it’s worth $80,000; the government will expect to see some tax money on that $30,000 gain. At the very minimum, I would set aside $10,000 (or approximately 1/3 of the capital gains) for Uncle Sam, but I would use the rest of the money and put it toward the mortgage.
What would you do? Would you pull out the money to pay off your house?