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Couple considers tapping into 401(k) for mortgage payments

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Q: My husband turns 65 next month, and his private medical disability of around $4,000 will end. We have a monthly mortgage of $2,600, and one child with two years left in college. I take home $2,300 a month. Our home is currently worth $1.2 million, close to downtown D.C. and a walkable metro stop.

Can we pay off our house by taking out $300,000 from his 401(k) retirement plan? He has an account balance of around $900,000 right now. We’re not ready to move, and I plan on working for the next 10 or so years. Once we move, we’re likely to move away from D.C. to a lower priced area several hours away.

A: You’re in a tough spot, and we understand why you’re worried. You have a large monthly mortgage payment and expenses that far outstrip the $2,300 you take home each month. You also plan on working for the next 10 years, and want to stay in your current home.

Let’s start with the disability payments. Your husband is currently receiving private medical disability payments that are scheduled to end when he turns 65. That’s what happens with Social Security disability payments. According to the Social Security Administration, any Social Security Disability Income (SSDI) payments you receive will end when you turn 65. At that point, your SSDI payments convert into retirement benefits, and should continue at the same amount as your SSDI payment.

Since you didn’t provide quite enough information in your email, we’ll give you some general guidance. The goal is for you to know what questions to ask so you can make a smart decision going forward.

Your husband has private medical disability payments of around $4,000 per month. He should, at age 65, be eligible for a Social Security retirement benefit. We don’t know what that amount would be, but you can call your local Social Security office to get more information about how much monthly income your husband is due.

If he is going to receive close to the $4,000 he is currently getting, then perhaps everything is going to be OK. But let’s assume he’s only going to get $2,500 per month. Then, you have a deficit of $1,500 to make up each month.

Next, let’s think about your costs. Are there any expenses you can cut back on? You should have your child borrow whatever they need in order to finish college. Or, perhaps they can apply for scholarships. Right now, paying anything out of pocket for them should be your last concern.

If you’ve refinanced your home in the last five or six years, or if it is your original loan, it’s likely your interest rate is less than 4%. If so, you should try to keep that loan and figure out a way to stay current on your payments. If that isn’t possible, and there is no other way for you to raise the extra $1,500 per month you need, then it’s time to look at your husband’s 401(k) plan.

Does the 401(k) plan allow loans? If it does, your husband may have to repay the funds within a specific period of time, usually five years. But often 401(k) loans are limited to individuals who are currently working at the company. Your husband hasn’t been working, so it’s unclear whether he’d be able to take advantage of a loan program.

But even if he is eligible, he may be better off withdrawing funds. But not all at once. If your husband simply withdraws the funds all at once, you’ll likely have a significant amount of federal income tax to pay on that withdrawal. Taking out $300,000 could push you both into a significantly higher tax bracket. For example, to net out $300,000, you might need to take out $450,000.

A better option might be to take out enough cash each year to cover the missing funds. So, if you need an extra $18,000 per year, consider withdrawing $25,000, paying whatever minor amount of taxes are owed, and using those funds to pay your mortgage. You’d be able to do that for 25 years, or more, without using up those funds.

And if you’re going to sell in 10 years, withdrawing just what you need each year should leave you with a win-win-win scenario: You’ll have some funds leftover in the 401(k) account which should continue to appreciate over time, you’ll have paid down your mortgage balance significantly, and hopefully your home will have continued to appreciate in value.

Note that your husband will have to make required minimum distributions (RMDs) starting at age 72, in seven years, based on life expectancy tables published by the IRS and the amount that he has in his retirement accounts.

According to the IRS, your RMD is calculated for each account by dividing the prior Dec. 31 balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes in Tables in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). If your husband was 72 today, his life expectancy would be 17.2 years. To calculate the RMD, divide the $900,000 he has in his account by 17.2. The RMD would be $52,325 for that year, far above the $18,000 you’d need to make ends meet.

We think you should sit down with a qualified financial advisor or Certified Financial Planner (CFP) to go through your situation in detail and uncover any other options. Good luck.

(Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through their website, bestmoneymoves.com.)

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