Multiple Streams Income

Ask anyone the following question, and you’ll get a pretty narrow set of responses: “Would you rather have more money, or less money?” The skeptic will rebut your question with, “That depends – how much money is ‘more’, exactly?” For the most part, I think most people will automatically answer “more,” and in fact the conventional wisdom in financial planning is that “more money is always better.” But is it really that cut-and-dried?

I was reading up on the topic of using one’s 401k to pay down their mortgage early, and was very surprised at what I found. The majority of posts and articles referencing this topic appear to recommend that you should not only leave your 401k alone; you should also prolong your mortgage for as long as possible.

This line of reasoning is flawed, in my opinion, because it forces you to plan based on three uncertain assumptions – that your 401k will earn an average annual return of 6-8%; that the mortgage income tax deduction will stay in effect perpetually; and that the dollar will remain stable and retain its value. I’ll address why each of these assumptions can be dangerous below.

The fact that many financial planners actually advise you to stay in debt should be quite alarming – but to many of us, it isn’t. Our cultural desensitization to debt is the very reason the economy has spiraled into crisis several times, even during the years since we’ve instituted so-called “fail-safes” in the banking industry. In order to get back on the right footing, we need to stop taking for granted the fact that we spend so much money that isn’t ours. That paradigm shift has to start on a personal level in order for it to make a difference in your financial life.

Your 401k Is An Investment

All models of 401k growth that I have ever seen indicate that over time, your gains will average out just like the stock market has. Never mind that the 401k hasn’t even been around that long – IRS code 401(k) was enacted in 1978 and became law in 1980. It took well into the late 80′s before the majority of companies offered 401k plans at all. So the performance of your retirement account over the 40-or-so years of your working life is estimated largely based on less than three decades of actual statistical data. And anyone who’s had a 401k account through the first part of the twenty-first century knows that it’s not all upward arrows. Had the 401k been enacted earlier and seen more prevalence during the recession of the late 70′s and early 80′s, I doubt the historical data would induce much more confidence.

I think 401k’s are a great way to save. But to say that you shouldn’t withdraw from your retirement to pay off your house is to assume the best possible outcome of a fallible investment vehicle. Paying off your mortgage, on the other hand, grants you a guaranteed return. You know for a fact that every dollar you save in interest is a dollar that goes straight into your pocket.

Tax Deductions Are Not Written In Stone

As long as America’s deficit keeps growing, lawmakers will always be looking for ways to cut corners. You are not entitled to your mortgage interest deductions, nor is there a guarantee that if you decide not to pay down your mortgage faster they’ll remain as they have for the next thirty years. Attempts have been made to cap the deduction in the past, and recently it came under review again. Don’t count on it being there forever, but instead take it as a gift and you’ll be in a better state of mind to make decisions as to where your money goes.

The Dollar Is Being Exploited

If you already own a home, you have paid a set price for a specific amount of land and a specific building. You will never have to worry about the rooms suddenly shrinking. Once you own it free and clear, you will probably never have to worry about a government employee coming in and deciding they’re taking your couch and coffee table to their office, either. Metaphorically speaking, your physical residence will never be demolished by the dollar. Its value in dollars may change, yes, but its value in terms of your lifestyle is at far less risk. Real property has that name for a reason. You can’t sleep on a bank account. You can’t wrap a thirteen-digit number around your shoulders to keep warm.

Future gains in your 401k and other savings and investment accounts, by contrast, are under the constant pressures of fluctuating currency values. The government can cause inflation (“quantitative easing,” as it’s currently being disguised) because they feel that heavy manipulation is preferable to a more hands-off approach. Realize that you have the ability to make choices that say, despite the downward spiral of our economy and the government’s longstanding ‘I-want-it-now’ monetary policy, you want to behave more responsibly.

The Value Of Certainty

My long-term strategy for retirement doesn’t center around me working late into my 50′s and 60′s and then living solely off of my 401k and government programs for the elderly (medicare and social security are fundamentally flawed, and I wouldn’t depend on them any more than I would depend on the government to protect the value of the dollar). I’m working toward a level of real property ownership that provides multiple streams income based on the current market at all times. That’s why, despite the additional tax I may incur, as soon as my 401k balance exceeds my remaining mortgage balance, I will objectively consider liquidating it in a strategic manner so as to eliminate my mortgage.

I don’t consider the possibility that my retirement account could continue to grow to be a deterrant; it could just as easily do so until a few years before I retire and then fall victim to the next financial crisis. No, I’d rather take more control (and yes, maybe less money) sooner, than leave my future in the hands of a crippled system run by greedy, irresponsible people. So is more money (or rather, the possibility of it) really always better? Not always. As far as I’m concerned, the peace of mind is what pays the greater dividends.

Don’t worry, I’m not going to re-hash the same tired financial advice you’ve always heard about the tax advantages of your 401k. Rather, I’m going to explain to you how the company you work for is actually paying for you to withdraw your retirement savings early.

If your job offers an employer match to your retirement account contributions – normally 50% of your contributions, up to a certain percentage of your salary – they will offset the taxation you’ll undergo if you pull that money early. Obviously if I want to retire early and liquidate my 401k, Uncle Sam is getting a huge slice of my pie. The key lies in the fact that as your employer matches 50% of your contributions, this results in employer-contributed funds amounting to 33% of your final account balance.

So let’s say I make $50,000 a year and I contribute 4% of my salary to my 401k. If my employer match is half that (2% in this case), I’m putting down $2,000 a year and my employer is contributing $1,000. Now to simplify this example, let’s say I have been working for ten years and I have $30,000 amassed. Again, for simplicity, we’ll say the market has been fluctuating so much that I’ve come out break-even. Doesn’t really matter how much extra I’ve earned for the purposes of this example.

$10,000 of the balance has been put there by the company I work for. Were I to withdraw the whole $30,000 early, I’d take a 35% tax penalty on the balance (25% tax bracket + 10% early withdrawal penalty). That comes out to $10,500 – just slightly more than the amount my employer has contributed. So essentially, I’m getting back just about all the money I put into my 401k – before taxes.

Now consider this: if I were to have put that money into a Roth IRA instead, I’d be subject to normal taxes before it went in anyway, right? So let’s say that 4% ($2,000) per year is taxed at 25% and put into a Roth. Not only do I not have the cushion of my employer match if I do wait until full retirement age to withdraw; I’m also only able to contribute $1,500 per year to my Roth. After ten years I’d have $15,000 assuming a break-even earnings rate.

In essence, this simplistic example shows how the employer match granted by the company you work for actually pays for you to take your retirement money early. I’m not trying to advocate that you pull your 401k before you’re due – that would be stupid, unless you are already set up and don’t need the full balance to live out your remaining years. As for myself, I plan/hope to retire well before age 59.5, so taking an early withdrawal of my balance is something that may one day become a legitimate option for me.

Most (if not all) financial advisers will caution you strongly against early withdrawals from a retirement account, unless it’s your last option, and your multiple streams income are not yielding enough for you to stay out of some seriously insurmountable debt. This example is simply to illustrate the fact that, on a worst-case-scenario basis, liquidating early will net you all the pre-tax money you’ve put into your account in this scenario. That’s not to say how much you stand to lose by making such a move, though.