Can I Cash Out My 401(k) to Pay Off My House?

by Mark Kennan, Demand Media
    There's no exception to early withdrawal penalties for paying off your house.

    There's no exception to early withdrawal penalties for paying off your house.

    For some people, paying off a house means eliminating the mortgage so you own the home free and clear. In other circumstances, it might mean getting out just enough to avoid foreclosure. Whether you can withdraw money from your 401(k) plan depends on your circumstances and whether you're still working for the company.

    While Still Employed

    While you're still working for the company, you can only take distributions from your 401(k) if you're at least 59-1/2 or if you've got a severe financial hardship. Needing money to avoid foreclosure on your primary residence would count, but just wanting to pay off your mortgage sooner won't. Even if you are facing foreclosure, your withdrawal is limited to the amount needed to take care of the problem, plus any applicable taxes and penalties. For example, you couldn't cite falling behind on your mortgage as a reason to take out enough money to pay off the whole balance.

    After Leaving Employment

    After you leave your job, the Internal Revenue Service rules don't restrict when you can withdraw money from your 401(k) account. You can use your entire 401(k) balance to pay off your mortgage. However, you'll still face the early withdrawal penalty if you're younger than 59-1/2, which probably means it'll cost you more in taxes and penalties than you'll save by paying off your house.

    No Penalty Exception

    In either case, if you take money out before turning 59-1/2, you will pay taxes and you'll also pay an extra 10 percent penalty. And the IRS doesn't offer an exemption for paying for your mortgage, even if you're in dire financial circumstances. If you withdraw $6,000 to avoid foreclosure on your home, for example, that is taxable income and you'll owe another $600 in penalties.

    Loan Alternative

    Instead of cashing out your 401(k) plan, consider applying for a loan if your plan allows it. You typically can borrow up to $50,000 or 50 percent of your vested account balance and repay it over five years. You won't permanently reduce the size of your nest egg, and you'll be paying the interest to yourself. When you pay the mortgage, the bank keeps the interest. When you male payments on your 401(k) loan, the interest is added to your balance. The downside is you miss out on the investment gains you would have earned if the money stayed in the 401(k) account.

    About the Author

    Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

    Photo Credits

    • Creatas/Creatas/Getty Images