Should I empty my 401(k) to pay off the mortgage before I retire?

The question

An illustrative letter.

The answer

My dear, wanting to walk out of your working life owing nothing is one of the most natural wishes there is. A paid-off home is security and peace, and I understand the pull. But the way you pay it off matters a great deal, because money in a pre-tax 401(k) is not quite all yours yet. Part of it belongs to the tax collector, and the larger the amount you take in one year, the larger that share becomes.

What does taking it all at once really cost?

Withdrawals from a traditional 401(k) count as ordinary income in the year you take them. To end up with $80,000 after tax, you have to withdraw more than $80,000, and the extra lands on top of whatever else you earn that year.

Here is a rough example for a single person. Suppose your other taxable income for the year, after deductions, came to about $40,000. To net $80,000, you would need to withdraw roughly $102,000, and about $22,000 of it would go to federal income tax, much of it at the 22 and 24 percent rates. Tennessee has no state income tax, which helps, but the federal bill alone is large. Married couples filing jointly have wider tax brackets, so their cost would be lower, though still real.

One more surprise: when a 401(k) pays a lump sum directly to you, the plan usually withholds 20 percent for federal tax. That may not cover the full bill, so you could owe more when you file.

How could it affect Medicare?

Medicare premiums for Part B and drug coverage rise for people with higher incomes, and they are based on your tax return from two years earlier. For 2026, the extra charges begin when income passes $109,000 for a single person or $218,000 for a married couple. A large one-year withdrawal could push you over that line and raise your premiums for a year, two years from now. If you are collecting Social Security, a large withdrawal can also make more of your benefit taxable.

Would it be better to wait until I retire?

Often, yes. If you take the money while you are still working, it stacks on top of your salary. In your first full year of retirement, your income will likely be lower, so more of the withdrawal could be taxed at lower rates. Some people find the years between retiring and starting required withdrawals, which begin at 73 or 75 depending on birth year, are a valuable window to draw down pre-tax savings gently. It is also worth asking whether your plan allows withdrawals while you are still employed; many do after age 59 and a half, but not all.

Can I spread it out?

Yes, and that is often the gentlest path. Instead of $80,000 in one year, you might take a portion each year for two or three years, keeping your income within a lower bracket, and pay the mortgage down in steps. Meanwhile, your regular payments keep shrinking the balance. A CPA can run the numbers for each approach and show you the total tax cost side by side.

What if my mortgage rate is low?

Then keeping the mortgage may cost less than paying it off. If your rate is modest, the interest you would save by paying it off could be smaller than the taxes you would pay to do it, and smaller than what that money might earn if it stayed invested. For instance, at a 4 percent rate, an $80,000 balance costs roughly $3,200 a year in interest at first, and less each year after, far less than a $22,000 tax bill. Look at your rate and your remaining years before deciding. There is no prize for paying off a cheap loan with expensive money.

What about having cash in retirement?

Keep some. Money paid into a house cannot easily be taken out again for a new roof, a medical bill or a car. Whatever you decide, keep an emergency fund outside the house, ideally several months of expenses, so a surprise in retirement does not send you back to the 401(k) at a bad time.

If part of your savings is in a Roth 401(k) or Roth IRA, qualified withdrawals from those accounts are tax-free and do not count toward the Medicare income test, which can make them a better source for paying down the mortgage. Check the rules for your accounts first.

So what is the wise path?

Peace of mind is worth something real, and wanting a paid-off home is reasonable. But you can usually reach it without handing a large share of your savings to taxes. Wait for your lower-income retirement years, spread the withdrawals, keep a cushion, and let a CPA check the plan before you act. You have worked hard for both the house and the savings. They both deserve careful handling.

One thing to do this week

Find your mortgage rate and balance, then ask a CPA to compare the tax cost of one withdrawal against spreading it over two or three years.