In the quest to become debt free people can sometimes make decisions that might negatively affect their future financial growth.
Recently there was a question on one of the social media websites from a woman who said that she and her husband were 60 years old and that he planned to retire at 65. She also said that they owed $200,000 on their home and were wondering if it made sense to withdraw money out of their 401(k) and purchase a smaller, cheaper home so that they wouldn’t have a mortgage as he headed into retirement.
Most financial advisor’s knee-jerk reaction to this would be “no!” because they’re against tapping into a retirement account and pillaging the future income that it will provide. However, because she and her husband are both over the age of 59 ½, they can take money out of their 401(k) without getting hit with any early withdrawal penalties.
Of course 65 is still quite young these days and any money in that 401(k) will more than likely have to last for at least a decade, if not two decades. Some financial advisors would say that rather than taking money out of it they should be aggressively putting more money in to their 401(k) next 5 years.
Assessing the reality of using that money to pay off their mortgage really requires that this couple seek the help of a financial advisor who can provide a thorough analysis of their financial situation.
They would need to take into consideration the projected return of their 401(k) investment as opposed to the interest rate that they would be paying on their mortgage in order to figure out which of the two options will keep more money in their respective pockets.
Another thing to look at would be the loss of tax deferrals as well as the loss of the compound growth on the money already in the 401(k) account. Indeed, the effect of compound growth on that money is one of the best reasons for keeping it in their 401(k). If it’s a Roth 401(k) is even better because any contributions and earnings that they make can be taken out tax-free.
Another important consideration is the taxes that they would owe on their withdrawals as well as the current market value of their home. Depending on where they live and the value that their home sits at currently, it might make sense too late until its market value increases.
In the end the right decision for this couple will ultimately depend on their specific retirement profile, including finances and taxes. Most financial advisors would tell them to focus on accumulating as much money in their retirement account as possible and only consider downsizing if they have enough cash on hand from the transaction costs as well as if downsizing reduces their monthly budget.
Money Saving says
Yeah, that’s a pretty bad idea overall for so many reasons… compounding interest being one of them.
Having cash on hand is better than having no debts … but no money either!