Have you ever thought about paying off your debts with your investments? For many of you, one of your final debts is your home loan and you just can’t wait for the day when that massive debt is paid off and you are 100% debt free. Over the years, your retirement account has amassed into a decent chunk of change, but recently, you have not seen the benefits of your investment.
In fact, your retirement fund might even be worth less than what it was 5 years ago, so why not just take it out and pay off the mortgage?! At least it would keep you from paying all that interest on your debt, right? While I agree that it would be nice to pay off your house, my gut reaction is to leave your investments alone. But let’s dig into some numbers and figure it out!
In order to accurately answer this question, we really need to have a sample scenario. Let’s work with the numbers below:
- Home Value: $90,000
- Remaining Mortgage: $60,000
- Monthly Payment: $500 (15 year loan with 12 years remaining)
- Mortgage Interest Rate: 5%
- 401(k) Value: $50,000
- Expected Future Growth of Investment Fund: 8%
- Tax Bracket: 25%
Take The Money Out and Pay Off The House
So what if you took the money out of your 401(k) and put it toward the home loan? Based on our numbers above, you might expect that you’ll simply remove the $50,000, dump it toward the principle of our home loan, and have only $10,000 remaining, but this is not correct. You’ve forgotten about a little thing called taxes.
If you earn between $70,700 and $142,700 (including the 401(k) deduction) as a married couple, you’ll have to pay a 25% tax on that 401(k) withdrawal. Also, if you are less than 59.5 years old, then you need to pay an additional 10% as a fee to the federal government. With these taxes and fees, your investment account is now worth only $32,500.
If you put that lump sum toward your mortgage, you’ll still have a balance of $27,500, which will take you another 5 years to pay off in full. So, at the end of the 5 years, you have no retirement savings, but your house will be paid in full with a value of $100,000.
Your Net Worth After 5 Years: $100,000
Keep The Money In Your Retirement Account
What if you just kept paying your regular house payments and allowed your retirement fund to grow at 8%? After the 5 years, your mortgage would dip down to about $45,000 and your investment account would rise from $50,000 to $75,000. Assuming your home is now worth $100,000, that means you have $55,000 in equity, which gives you a net worth of $130,000.
Your Net Worth After 5 Years: 130,000
The Best Plan
Based on the example we used above, it is clearly evident that removing your 401(k) to pay off the mortgage is not a good idea. Even though it seems like you’re earning nothing on your investments now, they will most likely grow in the future and far outperform the value in your home.
Have you ever thought about removing some money from your investments to pay off your home a little faster? What is your opinion now that you’ve read this article?