Using an IRA to Make the House Payment
Before you tap your IRA to pay off a mortgage, remember the money hasn't been taxed yet. Instead, consider a "mortgage IRA."


Q: I will retire in 18 months and my husband and I feel that we are well prepared financially. We have about $2 million in our IRAs and 401(k)s, plus a pension. I would really like to pay off the $500,000 mortgage on our house. The interest rate is only 4.5%, but we would feel better if we could get rid of our monthly payments. How can I use my retirement savings to pay off the house? We don’t have much savings outside of these accounts.
A: It would seem reasonable to simply take some retirement savings and use it to pay off your home mortgage. The challenge, however, is that your retirement accounts don’t only belong to you. You have the taxman as your silent partner.
You’ve certainly done a nice job accumulating money in your 401(k)s and IRAs, and while it’s tempting to view the money as yours do to with as you please, unfortunately, none of these dollars have been taxed. This is, of course, because you received a tax-deduction on the money you contributed to the accounts, and all of these earnings have grown tax-deferred.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.

Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The good news is that the level of tax that you’ll pay on your retirement savings is, at least in part, up to you. By that I mean that you have some control over how much in income taxes you’ll owe based upon how much you withdraw in any one year.
The U.S. income tax structure is highly progressive, so that the more income you have in any one year, the higher your marginal tax rate. For those with low income, the standard deduction and personal exemption will eliminate any income taxes, so their rate is essentially zero. However, for those at the high end of the income range, the top federal tax rate is 39.6%, plus another 3.8% on investment income for Obamacare. (Additionally, if you reside in a state with high income taxes, you can add on another 10%, give or take.)
Worst scenario? If you pulled money out of your retirement accounts to pay off the $500,000, by the time you paid off both the mortgage and the income taxes, it could cost you about $900,000.
By my calculations, the total interest costs for your loan for this year will be about $22,500 (4.5% times your mortgage balance of $500,000). This might sound like a lot, but it’s nothing compared to the roughly $400,000 you would owe the taxman if you attempted to pay off your house in a single year.
One method to reduce the tax burden would be to pay off your home over a few calendar years. For example, pay $166,000 per year for the next three years. To be clear, while this would certainly shrink your income tax bill, it would still cost you much more than the interest rate you are paying.
Because you’d like to eliminate your mortgage payment, here’s what I suggest you do: Set up a separate IRA and move $500,000 into it. Think of this as your “mortgage IRA.” Invest these dollars somewhat conservatively, and then establish a monthly withdrawal that is equal to your mortgage payment. Each month, right before your mortgage payment is due, you’ll have a deposit from your “mortgage IRA” that will be the same amount as your house payment.
Your monthly withdrawal from your IRA will be treated as taxable income, but you’ll be receiving a tax deduction for the majority of your mortgage payment, essentially eliminating the income tax consequences. You will trigger a small amount in taxes, but it will be insignificant, particularly for the next several years.
If you like the sound of this strategy, then make sure you have a long mortgage. If your mortgage is a 15-year loan, you might consider swapping it out for a 30-year, or maybe even a 40-year mortgage. The goal here is not to pay off the mortgage balance as quickly as possible, but to keep the mortgage payment as low as possible.
A couple items to keep in mind: First, if you had amassed $2 million in savings that had already been taxed, paying off your home would be simple and probably advisable. Many retirees like the idea of having their house debt-free. Second, it’s important that you invest this “mortgage IRA” in a manner that will produce a high degree of confidence that it will generate enough of a return to make the monthly withdrawals, but without taking on unnecessary risk.
Scott Hanson, CFP, answers your questions on a variety of topics and also co-hosts a weekly call-in radio program. Visit MoneyMatters.com to ask a question or to hear his show. Follow him on Twitter at @scotthansoncfp.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Scott Hanson, CFP, answers your questions on a variety of topics and also co-hosts a weekly call-in radio program. Visit HansonMcClain.com to ask a question or to hear his show. Follow him on Twitter at @scotthansoncfp.
-
Dow Hits New Intraday High on Fed Day: Stock Market Today
Not even the most important stock in the world could keep the oldest equity index down on a significant day for markets.
-
Savings Goal Calculator
Tools Want to know how much you need to save each month to reach your financial goals? Our calculator helps you build a realistic savings plan.
-
Gray Divorce Can Throw Your Retirement a Curveball: What to Know
If you're entering retirement and going through a divorce at the same time, you've got some work to do to shore up your long-term financial security.
-
How an Expired Passport Thwarted Blackmail (and What Other Important Documents You Should Keep)
An optometrist produced his expired passport to foil a blackmail attempt by the daughter of a former employee. After proving he was out of the country on the date of a forged diary entry, he took it a step further.
-
Optimize, Grow, Retain: The Power of Annual Client Reviews
Financial advisers can use annual reviews to help enhance client outcomes, strengthen relationships and build their practice.
-
Don't Disinherit Your Grandchildren: The Hidden Risks of Retirement Account Beneficiary Forms
Standard retirement account beneficiary forms may not be flexible enough to ensure your money passes to family members according to your wishes. Naming a trust as the contingent beneficiary can help avoid these issues. Here's how.
-
This Is How Life Insurance Can Fund Your Dreams Now
Beyond a death benefit, life insurance can provide significant financial value and flexibility through 'living benefits' while you are still alive, helping with expenses like education, business ventures or retirement.
-
Potential Trouble for Retirees: A Wealth Adviser's Guide to the OBBB's Impact on Retirement
While some provisions might help, others could push you into a higher tax bracket and raise your costs. Be strategic about Roth conversions, charitable donations, estate tax plans and health care expenditures.
-
One Small Step for Your Money, One Giant Leap for Retirement
Saving enough for retirement can sound as daunting as walking on the moon. But what would your future look like if you took one small step toward it this year?
-
This Is What You Really Need to Know About Medicare, From a Financial Expert
Health care costs are a significant retirement expense, and Medicare offers essential but complex coverage that requires careful planning. Here's how to navigate Medicare's various parts, enrollment periods and income-based costs.