Should I use my 401(k) to pay off my mortgage? 5 things to consider

When Myrna McGrath, a 75-year-old Iowa native, decided to retire at age 66, she had no intention of paying off her mortgage. “I gave it a lot of thought,” says McGrath, a former CPA. “But I earn more on my retirement plan—which is invested in stocks and mutual funds—than my mortgage costs me, so I decided to keep it.”

McGrath isn’t alone. More than 40% of homeowners age 65+ carry housing debt.1

Still, you may be hesitant to head into retirement with a house payment on your back. A mortgage is typically the biggest single expense in someone’s monthly retirement budget and can feel like a burden on a fixed income.

But continuing to make mortgage payments in retirement isn’t necessarily a bad thing, financially.

Graphic stating that 42% of homeowners age 65+ have housing debt..

It ultimately comes down to a few things: your age, the value of your mortgage, how you feel about debt, and your retirement income plan.

For McGrath, it was also a matter of convenience. “I have an escrow account with my mortgage holder, so I let them escrow my insurance costs and my property taxes,” McGrath says. “The convenience of having them do that is a benefit to me.”

Pros and cons to paying off your mortgage in retirement, at a glance:

ProsCons
Reduced anxiety about market movementsReduced investments, if you pull from your 401(k)
Improved cash flowLess spending money
Improved equity in your homePotential withdrawal fees/tax implications

If you’re contemplating paying off your mortgage in retirement, the decision may feel complicated. We’ll get you started with five key considerations.

1. Your age

Retiring early? You may face some financial penalties if you dip into your individual or employer-sponsored accounts.

If you’re younger than 59.5, that’s a 10% penalty for withdrawing early from your IRA or taking distributions from an employer-sponsored plan, such as a 401(k) or 403(b). That 10% could be a huge loss, depending on your financial goals and plan.

Beyond penalties, the more retirement funds you spend up front, the less you have to fall back on down the road. Know how much money you may need to sustain your lifestyle in retirement before you make large payoffs.

2. Your comfort with debt

Sometimes emotional factors are just as important as financial. “Who you are and how you feel about debt can outweigh the math,” says Stanley Poorman, a financial professional with Principal®. “Are you a person who sees a mortgage balance as the world on your shoulders, or are you comfortable carrying it into retirement?”

Depending on your financial goals and your comfort level with debt, making mortgage payments into retirement could free up funds for other expenses or priorities.

Learn more: “7 steps to pay off debt and save for retirement

3. The size of your mortgage

The point above doesn’t mean you shouldn’t consider the numbers. The value of your mortgage at retirement could make a huge difference in your payoff plan.

“You also need to understand your current tax situation and how taking distributions from your retirement accounts to pay off debt could cause you to change tax brackets and pay more tax than you would otherwise,” Poorman says.

If you’re retired, any pre-tax money taken out of your 401(k) is treated as income. So, for example, taking $100K out of your retirement plan to pay off your mortgage could easily bump you up into a higher tax bracket (and end up costing thousands in additional taxes). A balance of $10K probably won’t have as large of an impact.

Taking $100K out of your retirement plan to pay off your mortgage could bump you up into a higher tax bracket (and end up costing thousands in additional taxes). A balance of $10K probably won’t have as large of an impact.

If you continue to make monthly mortgage payments, the amount of interest you pay may be tax deductible. But that interest needs to be fairly high to make it count. The 2017 Tax Cuts and Job Acts nearly doubled the standard deduction, eliminating itemized deductions, such as mortgage interest, for many Americans.

Protect your mortgage.

If you choose to take your house payments with you in retirement, life insurance provides a form of mortgage protection. With a term insurance policy you can align the length of the term with the length of your mortgage.

4. Your nest egg

How many funding sources do you have for your retirement years? If you plan to pay off your mortgage, draw from the source that has the lowest interest rate first. For example, if your retirement account earns 6–7% and your savings account only earns 1.5%, you may want to keep your retirement money where it is and use your savings.

“Having different buckets of money to pull from is important,” Poorman says.

But be cautious not to drain your funds; maintain a safety net for life’s “what ifs.” If you don’t have a diverse mix and paying off your mortgage will deplete most of your hard-earned money, it might be best to keep making payments.

Learn more: “3 steps to help create a retirement income plan

5. Rates of return

Interest rates are still historically low, and the interest paid might be lower than the interest you’ll gain on investments. “Your home is an investment, and the return on my investment is also greater than my interest rate,” McGrath says. “If interest rates were high, it would be a different consideration.”

If the growth potential of your retirement savings is low compared to the interest rate on your mortgage, paying off your mortgage may be a good idea. But pre-tax contributions to your retirement account may offer better growth potential along with the possible tax benefit.

Graphic of a thumbtack. Tip: Your current asset allocation may need to be adjusted once you retire. Switching from saving to spending your savings may mean you still need some growth potential to keep up with inflation. (And so you don’t run out of money.) You will want to evaluate your risk tolerance before making changes.

Bottom line: The decision to pay off your mortgage in retirement isn’t cut and dry. It depends on a variety of factors, including your individual financial picture and goals. If you need help putting a plan in place or want ongoing guidance, a financial professional can help.

Ready to get started?

1 Joint Center for Housing Studies of Harvard University, 2020 Housing Insights

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other financial professionals on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Insurance products and plan administrative services provided through Principal Life Insurance Co. Securities offered through Principal Securities, Inc., 800-547-7754, member SIPC and/or independent broker-dealers. Principal Life, and Principal Securities are members of the Principal Financial Group®, Des Moines, Iowa 50392. Investment advisory products offered through Principal Advised Services, LLC. Principal Advised Services is a member of the Principal Financial Group®, Des Moines, IA 50392.