Paying Off My Mortgage Vs. Investing in My 401(k)

Putting money in a 401(k) is smart in more ways than one. Every penny you put in the account escapes income tax until you withdraw it. All the interest you earn is also tax free until you take it out. Even if the account only earns a modest rate of return, contributing to the max can still give you a great retirement cushion. If your employer contributes matching funds, the 401(k)'s financial advantages are that much stronger.

You may already have discovered that retirement accounts can lose money as well as earning it. Money you put in a 401(k) may not earn what you expect, but with a mortgage, your gains are guaranteed. Every extra payment you make on the principal cuts down on the amount you pay in interest. If your mortgage rate is 4 percent, making an extra $1,000 payment is as good as if you invested $1,000 at that rate of interest. Few investments are that sure.

Paying your mortgage early isn't such a great idea when the interest rates are low. If your mortgage interest rate is 4 percent but your 401(k) earns you 6 percent, putting money in your retirement account pays off much better. Mortgage interest is tax deductible, so if you itemize, your actual interest expense may be even less. Because of inflation, $17,000 toward your mortgage this year has more buying power than your payments in 10 years -- so many people choose to wait and invest current dollars in a 401(k).

If you lose your job, your issues switch from the best rate of return to the best way to stay afloat. The sooner you pay off the mortgage, the sooner you can stop worrying about foreclosure if you hit a long period of unemployment. If you're strongly debt-averse, reducing what you owe may give you more peace of mind than looking at a growing 401(k) account.