Should I use retirement savings to reduce mortgage given the following:

I'm sorry for your situation.

If 15 years of maximum savings only has you at $60K, I'm going to assume you are currently in the 15% bracket. A withdrawal will cost you 15% (and maybe push you into the 25% bracket) as well as the 10% penalty, and state tax. Don't do it.

Be sure your 401(k) has listed beneficiaries. Your wife will be able to take an annual withdrawal, and pay very little, probably 10%, maybe 15% worst case. You reference that she'd have a lump sum. Yes, but she won't have to take it all at once. She should be able to transfer the funds from the 401(k) to an IRA, and withdraw small amounts each year.

It's a very rare circumstance where an early 401(k) withdrawal actually makes any real economic sense.

As JoeTaxpayer says, "It's a very rare circumstance where an early 401(k) withdrawal actually makes any real economic sense."

Your statements that one year's salary for you is $60K and the combination of your spouse's income and yours puts you into the highest income tax bracket togetherlead to the conclusion that your spouse's income is considerably higher than yours. If this income will continue past your death (e.g. you two are not in a joint venture that will collapse when you pass away because she cannot do the workby herself), then it is very definitely to your joint advantage to leaveyour money in a tax-deferred account for as long as possible. Her incomeshould be enough to cover the mortgage payments. Also, rather thantake the money out and paying taxes at a high rate right now, your spouse can rollover the 401k money into an IRA and withdraw only small amounts per year,paying taxes spread over the years rather than in a lump sum.

It seems that you're asking for a legal/tax advice, and I vote to close the question as off-topic for that. This is not the place.

But on the second thought, I will share some of the ideas I have, provided of course that you will not consider them as any sort of tax advice whatsoever, and will not rely on it for any tax planning without verifying with a licensed professional.

Taking 401k money out just like that means that you are going to pay your taxes on that money plus additional 10% penalty. As @JoeTaxpayer said, this rarely makes economic sense.

However, taking 401K money out to pay your medical bills (which would otherwise be deductible, pay attention to the nuances) doesn't trigger the penalty. It looks like in your case you might (unfortunately) have a chance to use this provision.

Another case when you can withdraw money without penalty is disability, which according to what you describe is, unfortunately, a situation you're very likely to find yourself in.

Also, you can withdraw funds as income for a substantial period of time, and under certain conditions it will not be subject to the 10% penalty.

Of course, leaving it to the beneficiaries, as mentioned by others, is another and very valid option.

See publication 575 for specific details, and be sure to consult a tax professional before doing anything.