Hacking your 401k

Why we withdrew funds from our 401ks to pay down our mortgage

Most financial advisors consider it voodoo to even contemplate early withdrawal of your funds from retirement for any reason, but these same individuals most likely wouldn’t have a clue what the FIRE acronym stands for, and they defiantly don’t understand your individual situation.  They will scare you with things like the dreaded “10% early withdrawal penalty,” higher federal taxes, POTENTIAL lost income from the 401k, and many other things to try to scare you away from considering early withdraw, however, I am going to explain to you exactly why that is BS and why you should consider withdrawing funds now to pay off your debt, specifically mortgage debt.  2018 offered my wife and I a unique opportunity to withdraw retirement funds due to a transition to a new employer, and we took advantage of the opportunity.  We withdrew $75,000.00 from our retirement funds, and paid down a third of our mortgage debt.  Below I will outline the reasons why we did this, and why you should consider doing the same to achieve true financial independence, since as long as you have a mortgage you aren’t truly financially independent.

1. First, 2018 was the first year of the Trump tax cuts, which lowered our highest taxable bracket from 28% to 24%, meaning we automatically saved 4% in this federal POS automatically, compared to if we had done the same thing the year before.  Love him or hate him, this change coupled with the doubling of the standard deduction meant we paid significantly less in federal tax dollars to withdraw the funds in 2018.
2. The dreaded 10% early withdraw penalty:  This POS is designed to dissuade people like us from taking early withdraws, by creating another discriminatory POS aimed at young people.  How this isn’t discriminatory due to age is the topic for another conversation about how POS’s disproportionately effect young people.  The irony of this POS is the fact that by trying to encourage long term savings, the government steals an extra ten percent of your income, in the name of encouraging you to save money.  Ironic isn’t it??  However, thanks to number 1 above, this penalty really isn’t 10%, its 6%.  I know it cannot be both, but either way you look at it, you are getting a 4% discount now compared to just a few years ago.
3. Taxes and “lost income” from your investments.  By withdrawing your 401k balance now, you are taking a guarantee compared to a hypothetical guess.  To me, a guarantee is always better than a guess.  As the saying goes “a bird in the hand is better than two in the bush.”  Remember, every brokerage has some disclaimer stating something to the effect of past performance doesn’t indicate future returns, and it is quite likely you could be left with a mortgage you cannot afford, while your investments plummet, just like many people experienced in 2008.  You are also guaranteeing current tax rates.  My tax rate for this withdrawal was 24%.  What if in 30 years when I withdraw from my retirement the tax rate is 50%?  Under those circumstances, I think taking the money now would be very beneficial vs waiting until retirement. As we have discussed before, my expectation is in order to pay for the many POS’s and constantly evolving socialized programs such as Medicare for all, Universal Basic Income, free college, and student loan forgiveness for all, tax rates will only continue to climb.  One of the few major strongholds of wealth left in this nation is found in 401k and other retirement accounts, meaning the government will find a way to steal more money from these accounts to pay for more POS’s.  As time progresses, I expect that the taxable rates on these accounts will continue to expand.  When your broker tells you that you will most likely have a lower tax bracket in retirement, they are basing their GUESS on current tax rates, expecting them to be the same 30 years from now when you reach the traditional retirement age.  I will guarantee that these tax rates will change over the next 30 years, and they will not be in your favor.  Taking the guarantee now does reduce your possible future income, but this is a hypothetical number, compared to a guaranteed number.
4. Mortgage interest savings.  When we did this, we owed around $200,000.00 on our mortgage.   A traditional 30-year loan at 4% interest on this balance, would result in a total of 143,739.01 in interest on the life of the loan.  However, by applying a 1 time $75,000.00 payment to the mortgage, you would reduce the cumulative interest to $40,401.02, for a grand total savings of over $100,000.00 in interest.  This is a GUARANTEED savings of $100,000.00, compared to a hypothetical loss of some unknown amount due to the effect of compound interest and future taxation.  This also cuts your mortgage in half from 30 years to 15 years, reducing the chances of losing your home to the bank for any number of unforeseen circumstances, by 50%.  
5. Financial independence.  By doing this now, you guarantee true financial independence in half the time of your traditional mortgage.  You guarantee a savings of over $100,000.00 over the life of your loan, but you also need to look at “societal norms” and how they need to change in the FIRE community. You don’t need millions of dollars in “retirement.”  In fact, as soon as you achieve a true worth of 0.00 by paying off your home, you have effectively reached FIRE. This is because now you only have to worry about groceries, since you no longer have to worry about housing and healthcare costs, since you now know how to qualify for Medicaid under the expansion program.  
6. Maximal 401k and IRA contributions.  Currently, my wife and I only contribute 5% to our 401k accounts, and do not participate in any IRAs.  The reason is we get a 5% match from our company for the 5% contribution, and we use the remainder of our income to pay off our debt ASAP.  As soon as we pay off our debt, we will be able to then max out our accounts, resulting in saving nearly $52,000.00 in IRA and 401K accounts, compared to putting away a fraction of that now.  Should we have continued with a traditional 30-year mortgage, this would have not only guaranteed losing the about $100,000.00 to interest, but we would not have been able to maximize our retirement contributions saving over $50,000.00 annually in retirement accounts alone, as our income would not have been sufficient to do both.  By doing this when you are younger, you guarantee that you will pay off your home soon enough to maximize your retirement contributions and make up the difference for the few years you only saved the bare minimum.
7. Peace of mind.  To me, this is the best thing about the FIRE lifestyle.  After all, we’re all here to find a better way to live life, and pay our bills along the way.  The peace of mind that comes with knowing in your 20s or early 30s that for the rest of your lifetime you will no longer have to worry about a mortgage or rent payment is priceless.  Since you don’t have to worry about losing your home to the bank anymore, it makes weathering changes in the market and in your retirement accounts much more manageable, and less stressful.  Because who cares what the market does when all of your monthly expenses can be covered by working part time or with a side gig since you have your housing and healthcare covered?

In conclusion, I think guarantees in the FIRE life are the best option over hypothetical rates of return.  Guarantees allow you to achieve FIRE, and maintain FIRE, regardless of market conditions or unforeseen issues such as COVID-19, and there are few guarantees in the financial world.  By taking money from your retirement accounts now to pay down debt, especially mortgage debt, you allow yourself to achieve FIRE with the peace of mind that you will have a roof over your head for the remainder of your lifetime, while eliminating one of the biggest monthly expenditures of the typical American family.  Additionally, you will be able to save more money in the long run, since you will be able to max out your retirement accounts, while having the peace of mind that should your retirement accounts tumble, your house isn’t in jeopardy.  Remember, you only have one life to live, so do what you can now to reduce your debt and enjoy your limited time with those you love the most.