so recently a subscriber emailed me and asked me a question regarding their
parents 401k that question was as follows hi Mike
my mom has been retired from the workforce now for several years and is
wondering if it would be wise to use her 401k to pay off the existing mortgage on
her home well the answer is it depends but by the end of this video I believe
you'll have the tools and information necessary to help you make that decision
for yourself if you're wondering the same thing in this video we're going to
discuss two main things the first thing we're gonna discuss is the pros and cons
as well as the factors that should be taken into consideration before you
start withdrawing any money at all from your 401k to pay off your home secondly
if you decide you want to go through with paying off your mortgage early with
your 401k we will discuss a strategic way to go about that process so you can
pay the least amount of tax possible during that transaction let's begin! For
many of us the largest and last debt we have to pay off is our home mortgage at
this point in your life maybe you are thinking about having peace of mind that
the house is finally paid off or you want to experience what it feels like to
be completely debt-free because you have never been debt-free before I totally
understand your desire to feel that way because it can bring about good emotions
but first what we need to do is completely remove our feelings and
emotions completely out of this equation so that we make sure we're making a
sound financial decision with our 401k money now let's talk about the pros and
cons of using your 401k to pay off your mortgage I have three pros and three
cons starting with the pros the first pro of you use your 401k to pay off your
mortgage is it you will have peace of mind knowing you own your home outright
secondly you will be saving money on mortgage interest and third you will
need less money to live on going forward because you will no longer have a
mortgage payment wrapped around your neck now let's talk about the cons the
first con is you give up the potential compounding interest impact of your 401k
investments and possibly trading your investments for a lower rate of return
based on the home mortgage interest rate secondly assuming you do not have other
sources of income outside of your 401k you run the risk of becoming house rich
but cash-poor which could potentially put you in a position later on where you
have to take on debt because you have no other available funds you don't want to
have to take a mortgage equity loan later on just to pay your normal
expenses because that's gonna put your house at risk
the third con is without careful planning you might pay more taxes than
you need to on your 401k distributions in order to pay off your mortgage so
basically if you don't do this carefully you can end up having a huge tax bill
and you draw down your 401k faster than you ever wanted to to begin with so guys
those were some pros and cons obviously there's more pros and cons out there but
now let's talk about some specific factors to consider when going about
this decision making process I have seven factors for you to consider and
also let's begin the first factor to take into consideration is one what is
your annual mortgage rate two what is the average annual rate of return on
your 401k over the past five to ten years is it higher or less than your
mortgage rate I find in the real world when I ask people that question most
people have absolutely no idea it's very sad of what their actual average return
is within their 401k so if you don't know ask somebody to help you or contact
the brokerage firm where your 401k assets are held and ask them to help you
determine what your average rate of return is in your account over the past
year five years ten years etc the third factor is what is your marginal tax rate
since you have retired this is important when determining how much tax you will
have to pay when you withdraw from your 401k you can get a rough idea of your
income tax rate based on the 2018 tax tables I'll provide a link in the
description section of this video where you can go to find those tax tables I'll
also link up a video I did to give you a step-by-step guide of how to determine
your marginal tax rate for the fourth factor is how much would you actually
need to withdraw from your 401k to pay off your home with net of taxes many
people don't understand that if you owe a hundred grand on your mortgage left
let's say you might have to take out like 120 to 140 thousand dollars from
your 401k because of the taxes used to to pay on that money the fifth factor is
do you have emergency fund of three to six months worth of expensives saved up
for emergencies that can arise the sixth factor is do you have other sources of
income to get by besides Social Security how will you get by it for if emergency
comes up and the seventh and last factor that I have for you guys to consider is
are you okay with taking risk in the markets by keeping your money invested
so guys there's obviously more factors than that but those are seven when I
really thought through this of that at least from my perspective of what I
would want to think through before making any decisions at all with my 401
K go through those take the time do your homework and get the answers to your to
those questions for yourself work through it to help you make a better
decision let's say chipper has ten years left on his mortgage under his current
payment plan he owes $100,000 left on his mortgage and his mortgage rate is
four percent if he continues to pay the payments for this for the next ten years
by the time he pays off his mortgage he will have incurred an additional twenty
one thousand five hundred dollars in interest now we look over chippers 401 K
and upon further analysis we realized he has been able to grow his investments
within his 401 K every year on average at the rate of 7% net of investment fees
assuming chipper has 100,000 invested in his 401 K if we let that money compound
for ten years at an average annual rate of 7% his $100,000 would grow to two
hundred thousand nine hundred and sixty six dollars over that ten-year span now
wait you say Mike that money hasn't been taxed yet true good points if we assume
chippers net effective tax rate is 30 percent chipper would still come out
ahead by keeping this money invested in his 401 K because he would still come
out with 70 thousand six hundred twenty six dollars after-tax in this scenario
now compare the 70 thousand six hundred twenty six dollars against the
twenty-one thousand and five hundred dollars in interest he would have saved
by paying off the mortgage early by not paying off his mortgage early chipper
actually came out ahead in total by 49 thousand dollars so chipper was by
investing in his 401k and not using that money to pay off his mortgage early he
actually in this scenario came out forty nine thousand dollars richer now of
course you and I both know the returns in its 401k are not guaranteed the
market could go up or it could go down we're not going to ignore that elephant
in the room remember one of the risks of and keeping your money invested in your
401k is that you're the market could be volatile
just like in the past ten years we've had a little longest-running bull market
history so we suspect some volatility going forward but nobody knows exactly
when but just keep that in mind if you do decide to keep your money invest in
your 401k you have to be able to accept that risk that you're taking on at the
end of the day once you have considered the pros and cons as well as the factors
we have discussed in this video it still comes down to your personal decision on
the matter I'm not gonna knock you if you want to use your 401k to pay off
your mortgage that's totally up to you and Who am I to
tell you otherwise it's your life it's your money but just be thinking about
these things okay that's the point of this video take these things into
consideration if you decide in the end that you ultimately want to use your
401k assets to pay off your mortgage or pay down your mortgage faster let me
give you a few tips so you can go about that process and pay the least amount of
tax possible the first thing you want to do in this process is determine your
outstanding mortgage balance next remember that your 401k distributions
are taxed at ordinary income tax rates ordinary income tax rates are based on
your marginal tax rate which follows the tax brackets I mentioned earlier in this
video what you want to avoid is paying more tax on your 401k distributions than
you need to sadly what I've seen in the real world is that many people don't
even understand the concept that they're gonna be taxed on these this money that
they take out of their 401k and what I see happen as a major mistake all the
time is that someone will go and take a huge distribution of their 401k during
that year and that raises their overall income to a much higher amount all this
additional extra income coming out of their 401k pushes them into a higher tax
bracket so during this process to minimize your tax burden you want to do
some basic tax before you start taking large amounts of
money out of your 401k you can do it yourself or you can work with a CPA or
enrolled agent to help you do this but basically you want to project in
total what you're gonna make for the year from all your sources of income
before you take any additional money from your 401k because that's gonna help
you determine where your tax brackets are gonna where you're gonna fall within
the tax brackets once you determine how much total income you expect to make for
the year then you want to determine how far away you are in terms of income from
hitting that Nicks higher tax bracket now what I would suggest or at least for
you to consider is to you because you want to stay below that next tax bracket
so that you're taking this money out of your 401k as cheaply as possible as tax
efficiently as you can let's say that you project your income for the year and
you determine your $20,000 in income away from the next higher tax bracket so
you look at your projected income you look at the tax brackets and of this
twenty thousand maybe instead of taking twenty thousand out and bumping up right
against that bracket maybe you take fifteen thousand out or sixteen thousand
out of a 401k at that point when you take out that sixteen thousand you then
set aside money for income taxes for federal and state especially if you live
in a state that has income taxes as well put that money aside for taxes let's say
your taxes on that is like four grand okay so you've got you pulled out
sixteen thousand you set aside four thousand for taxes because you know
you're gonna have to pay them the extra twelve thousand that remains that's the
amount of extra money you drop on your mortgage and apply it completely to
principle and then as the next year rolls around you do the same thing you
project your income figure out how far away you are from hitting the next tax
brackets and pull out a little bit more and keep paying on that principle but
make sure you setting money aside for that taxes as well and you keep doing
that until your mortgage is completely paid off
yeah sure you're paying a little bit of extra interest but at least you're not
being hit with a huge tax bill or you're minimizing your taxes as much as
possible by spreading out your distributions from your 401k
paying off your mortgage a little more slowly you might be able to save
hundreds or even thousands of dollars of additional income taxes that you would
have otherwise paid had you taking all that money out at once
from experience do you guys think most people do it this way you guys think
they'd spread out their distributions and have a strategic approach no no no
no I can tell you from experience that most people don't do that in fact they
they usually just take out a huge sum of money they don't tell their accountant
they never talk to their to their accountant at all before they even go
and do it and then they're surprised when it comes
to tax time and we have to we see this huge distribution all of a sudden as
their accountant and we're like well why didn't you tell me about this I could
have saved you a ton of taxes and so what ends up happening is the person has
to pay maybe ten twenty thousand dollars in taxes and they're completely shocked
by how much tax they actually have to pay and it is it'll make you sick to
your stomach if you do that to yourself planning is the key to this thing being
as successful as possible for you as we wrap up this video I'm gonna leave you
guys with this for some people paying off their mortgage using their 401k
makes perfect financial sense it makes financial sense for them based on their
personal goals and their personal situation now for me personally do I
ever see myself using my 401k to pay off my mortgage as of right now I don't see
myself doing that in the future what do you guys think is do you think
paying off your mortgage using your 401k is a good idea is it a bad idea why are
why not let me know in that comment section down below alright guys well
that is all the information I have for you today yeah if you guys liked the
video make sure you drop a like before you leave be sure to share this
information with a friend especially if you know somebody who's retired and
who's thinking about paying out their mortgage because maybe their mortgage is
the last that they have and they're looking over to their 401k to do it last
but not least if you're new to money in life TV well welcome to the channel
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subscribe to the channel if you have not already for our newest weekly uploads
well thank you so much chipper and I had a blast hanging out with you once again
as always here on money and live TV have a great week everybody now remember the
information you learned in this video take it and use it to live your life on
gauged I'll see you guys in the next video take care everybody peace