The quest to become debt-free can sometimes result in making decisions that may impede future financial growth. I’ve been thinking about this a lot after getting this question on Facebook:
Myra Davis asks:
“My husband and I are 60. He plans to retire at 65. We owe $200,000 on our home. Does it make sense to withdraw from our 401(k) to purchase a smaller cheaper home and have no mortgage?
My first reaction is “No way!” I do not like the idea of tapping into a retirement account and raiding your financial future.
(Read more: Love & money: Should you merge your assets?)
Most financial advisers usually warn against 401(k) loans or withdrawals. But you and your husband can take withdrawals from a 401(k) without an early withdrawal penalty since you’re over 59½-years-old.
Still, even if your husband retires at 65—his 401(k) money may have to last two decades or longer in retirement. It may make more sense to keep aggressively putting away money into his 401(k) over the next five years.
(Read more: We’re in our 30s. How much should we be saving?)
To make a reasonable assessment of whether it makes sense to use money from his 401(k) to pay off your mortgage, you really need to work with a financial advisor who can do a thorough analysis. You can find one in your area through the financial planning association at www.fpanet.org or the national association of personal financial advisors at www.napfa.org.
The analysis into consideration:
- The projected rate of return on your 401(k) investments vs. the interest rate you would pay on a mortgage—to figure out which option will result in more money in your pockets.
- I would also look at the loss of tax deferrals and loss of the benefit of compound growth on the amount in your 401(k) account. The compound growth effect is one of the best reasons for keeping money in your 401(k). And if any of that money is in a Roth 401(k), the contributions and earnings could be taken out tax-free.
- Taxes are an important factor. You need to figure out the amount of income tax you would owe on the withdrawal. Also look at the current market value of your home and whether it makes sense to wait until the market value increases.
The right answer for you will depend on your specific financial, tax and retirement profile. But generally speaking, I’d focus on accumulating a sufficient nest egg to support yourselves in retirement and then consider downsizing if you have enough cash on hand from the transaction costs and it cuts down your monthly budget.
—By CNBC’s Sharon Epperson. If you have a question for me, follow me on Twitter@sharon_epperson. Just tweet your questions about how to better manage, grow or protect your money at #GetAPlan. Or send an email to firstname.lastname@example.org.