I’m 46 and a single mother. Should I empty my 401(k) to pay off my house? There’s $128,000 on the mortgage.

Dear Quentin,

I’m a 46-year-old woman, and single mother to a 14-year-old boy. I bought a centrally located house in Miami after the housing market crash in 2010 for $167,000. The house is small but has a big lot in front of it, and I currently owe $128,000. The house is now worth about $400,000.

I have an annual income of $108,000, and other than the house I have no other major debt. I owe $6,000 on my car, and about $5,000 in credit cards.

I currently have $114,000 in my 401(k), which I have been thinking about taking out and using to pay for my house. I understand I will pay taxes and a penalty, but whatever I get back, along with a portion of my savings, will help pay off my house.

‘I understand I will pay taxes and a penalty, but whatever I get back, along with a portion of my savings, will help pay off my house.’

The thought of not having to worry about paying for my house, losing my home or having any large debt gives me peace. I currently make good money, and not having to pay a monthly mortgage will help increase my savings.

My savings are in a money-market account with a 3.80% APY.

I don’t feel my 401(k) will grow at a pace that will be of much significance for my retirement. I’m also aware that with the financial uncertainty we currently live under, my 401(k) can come down and I would lose the opportunity to pay off my house.

After paying off my house, I may open a Roth IRA.

Is this a sound financial move?

Homeowner & Mother

Dear H&M,

It might seem like dipping into that 401(k) honey pot will make your life easier. I disagree. You say it will give you peace of mind to know your house is paid off, which can feel temporarily empowering and intoxicating — but it’s a bad decision. Your anxiety about having your house paid off will be alleviated, but you may end up finding another reason for anxiety, and that reason may be regret at having plundered this work-based savings account.

On a practical level, you have a well-paid job and, if you bought your home in 2010, you’re probably paying an interest rate on a 30-year mortgage of around 4.69%, or thereabouts. I would have preferred for you to have refinanced your mortgage a couple of years ago when rates were lower, but assuming you did not do that, it’s still not a bad rate by current standards (the average 30-year fixed-rate mortgage now hovers at around 6.85%).

Furthermore, you will have to pay a 10% penalty on withdrawing from your 401(k) before the age of 59½. And then you will have to pay income tax on your withdrawal. Given that you earn a good salary, you could end up paying an income-tax rate of 32%. You could end up walking away with something closer to $66,000. That’s a rough figure, sure, but it illustrates that the administrator of your 401(k) plan and Uncle Sam will be helping themselves to your honey pot before you do.

You say it will give you peace of mind to know your house is paid off, which can feel temporarily empowering, but it’s a bad decision.

Having all your savings in a money-market account is not a great long-term plan. You should need aim to have an emergency savings account in a high-yield savings account — perhaps a CD or online savings account, given that rates are currently relatively high. Assuming your teenager will be applying to college soon, it’s also worth remembering that your 401(k) is not taken into account calculations are taken for financial aid.

Weller Group, a financial adviser, has some cautionary words. “Be careful, however, about taking money out of your IRA (or any retirement account) to pay for college. Though the tax law permits penalty-free withdrawals from a traditional or Roth IRA to pay for qualified college costs, doing so may jeopardize financial aid in a future year. The entire withdrawal, including principal and earnings, counts as income on a future year’s aid application.”

It’s always a good time to open a savings account. Generally, Roth IRAs make most sense for younger people because they’re paying tax on the money they put into these accounts instead upon the withdrawal of the money from a Roth IRA and, when people are in their 20s, they tend to have a lower tax bracket. There’s no age limit to opening a Roth IRA account, but the longer you leave the money in a Roth IRA or 401(k), the more that compound interest you will earn.

Gains from a Roth IRA, as you point out, are not taxable if the account has been up and running for five years and you are over 59½. One of the big advantages to a Roth IRA is the flexibility it affords. You can withdraw money from a Roth without penalty, so if you have a medical emergency or you want to further your education at any point in your life, you can do that. However, there are income limits to opening a Roth IRA. 

Your first priority should be to pay off your credit card. You are throwing money away by holding a balance. The average credit-card interest rate is currently around 23.84% — the highest rate since the personal-finance platform LendingTree began tracking rates monthly in 2019. This is a classic case of — and forgive the cliché — not seeing the forest for the trees. You are looking at the big picture, and missing more important specifics. 

Bottom line: You’ve come a long way. Don’t make any hasty decisions that give you the illusion of control.

Yocan email The Moneyist with any financial and ethical questions at qfottrell@marketwatch.com, and follow Quentin Fottrell on Twitter.

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