Home Equity Line vs 401k distribution or Taxes vs Interest Payment

[MichaelD180397]

Hello group - 

Background: My wife and I have to decided to help our age-in-place plan by proceeding with some major renovations to our current home.  We anticipate $100,000 as the cost of the renovation which would take approximately 3 months and must be paid as we go.  We've got about $50,000 in the emergency fund, cash, and we take in just enough monthly via pension and social security to pay our expenses.  We have over a million in the 401K which we haven't tapped yet.  Looking locally I've found a Home Equity Line of Credit with no upfront costs at an excellent rate of prime - 0.5%.  That would be 2.75% right now.

The question is:  Is it wiser to take a distribution of $130,000 from the 401k (state and federal taxes) or borrow the $100,000 at 2.75% and pay it down over 10 years, thus avoiding a substaintial outlay from the 401k all at once.

As always, your thoughts will be appreciated and considered as thoughts only and we will make our own decision and take total responsibility for the consequences.  Thanks gang.

[MichaelD180397]

Thanks everyone for joining in on this discussion.  You all made excellent points and helped me decide on our best approach.  In the end I think that @Tonster521 has a complete analysis of the problem and the solution.  I was nearly at the same point after reading all of your comments.  This is an excellent resource, I think, for us all.

If anything should prove to be wrong about our assumptions I'll revisit this thread and let you all know.  Cheers everyone!  Be safe and healthy.

[Tonster521 · Accepted solution]

Some very good comments have been posted. You may have already determined the Federal and State impact (approx. $30,000) to net $100,000 from your 401 K. However, you need to add to that $30,000 the cost that $130,000 will no longer be working for you accumulating earnings. For example, if your 401 K is earning 3%, the additional cost is $3,900 ( $130,000 X .03). So, a 401 K distribution will cost you approx. $30,000 in taxes and $3,900 in lost earnings or $33,900. the Home Equity Loan (HEL) will cost you approx. $14,493 over 10 years @ 2.75%. It is unknown if the HEL has a variable interest rate. If so, the interest cost may be greater. So, look for a fixed rate 10 year HEL or mortgage. Remember, you amortizing the HEL or mortgage. So, you are paying interest on a lessor amount each month. An internet mortgage calculator for $100,000 @ 2.75% for 10 years indicates a monthly payment of about $954. Even if you need to withdraw $11,446 ($954 X 12) from your 401 K to meet those monthly payments, you will find the HEL  or mortgage will cost you less. Hope this helps.

[MichaelD180397]

@Tonster521 I think you've nailed it.  Taxes and interest payments had me going back and forth to the spreadsheet formulas a few times but I had neglected both the amortization and the lost gains from the 401k.

FWIW the HELOC is adjustable, but at prime minus 0.5% it's still a winner over any other available loan options.  Rate increase may cause me to change the loan but huge changes in the prime rate have not been the norm for quite a while so there should be plenty of warning prior to any significant event.   Thanks very much.

[GailL1]

Do you currently have a mortgage?  I will assume not -

If so, personally, I would opt for the HELOC -that way, you can avoid the tax consequences of 401k money liquidation, get a good rate on the HELOC and use it as the need arises.  Maybe it would make you think twice about what you actually need to do for this life-style planning.

A couple of cautions:

• Make sure you plan for the payments on the HELOC - additional principle payments to pay it off as fast as you can.  I am sure that is an adjustable HELOC rate - and interest rates may rise -
• Make sure that your long term financial planning considers the event of one of you not being around and the survivor can meet the financial demands on any loss of income (Social Security).

I hate mention that last part but I have found that many people just don't think about that in the long run - it probably won't affect you and your wife like other couples that I have known - sounds like you have prepared pretty well.  Make sure you have included life insurance on each of you for the other.

That's my 2 cents and it will only cost you a nickel.💰 😀   Good Luck

[MichaelD180397]

Hi Gail - 

Thanks for that. I think you've summed up our thoughts on the HELOC vs 401K distribution and the taxes that go along with that.  I should have mentioned that we do still owe some on the mortgage, about 25% of the current value.  I'm still puzzling out the actual math on this move though.  I'm hoping someone who's made this decision already has a handy spreadsheet that they'd like to share.  But in the meantime I'm looking forward to some input from this group.  Cheers.

[sktn77a]

I guess the only issue with a HELOC loan is the potential for the variable rate to go up when the US Financial chickens come home to roost!  Interest rates could stay low for the next 10 years or they could spike as the US debt gets (is) out of control - think historical Germany, Argentina, etc.  Have you explored a fixed rate refinance of your current mortgage to take out $100,000 in cash?