Don't raid your 401(k) to pay off mortgage

On the Money

Your Money

September 17, 2006|By Gail Marksjarvis | Gail Marksjarvis,Chicago Tribune

I am a 58-year-old male, and might be losing my job soon. I don't think I will be able to get another decent job, and my wife makes only $19,800 at her full-time job. I will be able to get health insurance through my wife's employer. We owe $117,000 on our home, and I'm thinking of removing $170,000 from my 401(k) to pay off the mortgage and cover the 401(k) taxes. I'm paying 5.63 percent on my mortgage and doubt that I would make more than that if I kept investing the 401(k) money, because I am a conservative investor. So getting rid of the mortgage seems to be a sensible strategy. What are your thoughts?

- L.O., Grand Rapids, Mich.

I ran your question by a half-dozen financial planners and certified public accountants, and none thought you should do this.

If you remove $170,000, all agreed you would incur a large, unnecessary tax bill and cut yourself far short of the retirement money you are likely to need.

The strategy would give you the peace of mind for the moment, but in the long run it would put you in worse shape.

If, after the withdrawal, you are left with only about $300,000 in your 401(k), as you indicate, it would allow you to remove only about $12,000 to $15,000 a year during retirement. So that you don't run out of money in retirement, financial planners say to remove no more than 4 percent to 5 percent of your nest egg per year.

So they suggest you leave the 401(k) intact and keep growing the money in an account sheltered from taxes.

There is no hurry to do anything now. Maybe you won't lose your job. Under federal 401(k) rules, people are allowed to take money out of 401(k) plans without penalty at age 55 if they lose their jobs, said Steven Leventhal, a Bend, Ore., attorney. But if they don't get laid off, they can't touch the money until they are 59 1/2 .

So if you keep your job, that will be a relief, but Uncle Sam would smack you with a 10 percent penalty for removing 401(k) money. Then you will be required to pay income tax on the $170,000. Mixed in with the pay you and your wife have received this year, you could jump a couple of tax brackets and perhaps double your taxes, says Warren McIntyre, a Troy, Mich., financial planner.

Even if you lose your job, McIntyre and other planners would not advise you to take $170,000 out of the 401(k) immediately. Instead, they suggest you can have the same peace of mind by knowing that later you can take money out in smaller amounts. If you can't find an adequate job, you could, for example, take about $8,600 out of the 401(k) each year you needed it, McIntyre said.

That would benefit you in two ways. Because you would be out of work, or working part time, your income would be low. So even with the tax on your 401(k) withdrawals, the tax bite probably would be lower than what you face now.

In addition, by leaving a larger sum of money in your 401(k), you could enhance the impact of investment returns.

Although you say you are a conservative investor and not likely to earn more than your 5.6 percent mortgage payment, Lincolnwood, Ill., financial adviser David Strulowitz said your mortgage is really costing you only about 4.2 percent once you figure in the tax deduction you receive for it. So compare your conservative investments to a 4.2 percent return - not 5.6 percent, he said.

He said you can get a better return than you think. Even the average money-market fund is yielding 4.73 percent, and some, such as Vanguard Prime Money Market, are over 5 percent, according to iMoneynet.com.

gmarksjarvis@tribune.com

You can also leave a message for Gail MarksJarvis at 312-222-4264.

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