A question by I am older than 59.5 and it’s time for a new car. I am thinking about paying cash rather than financing it through the dealer or a bank. If I take money out of my IRA will it cost me more in the long run? Or, is it a smart way to go? Thanks! ??
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Provide a response using the comment section. After review we will update the answers.
Your Roth IRA Has Been in Existence for Five Years or More
You may be able to fulfill your desire to own an automobile with the aid of a Roth IRA. Since the account is typically funded with after-tax money, your withdrawal won’t result in you having to pay more taxes. The five-year requirement must be met by your Roth IRA, though.
According to the five-year rule, you can only take tax-free distributions from your Roth IRA if the account has been open for at least five years and you are at least 59 1/2 years old. In contrast, if your Roth IRA is more than five years old and you require money for a suitable vehicle because you are fully and permanently disabled, you can still do so.
It will most likely cost you more. Depending on your credit and income – the interest rate on the loan would have to cost more than your marginal tax rate to make sense. I am making the assumption that your IRA is entirely pretax money. If not – it depends on the ratio of pretax money to post tax money and whether you have actually filed a form 8606 to track your basis in your ira. This is also assuming that you are really going to pay yourself back in the IRA. If you can afford to make payments to your IRA – then you must still be working and under 70.5. If that is the case – make sure that you are only planning on making less than the max annual contribution. You would actually be taking a distribution and making a contribution after 60 days of the withdrawal. The IRA contribution would have to be deductible (based on your income) for this strategy to make any sense at all. If you are limited by income to make a deductible contribution – it’s a no brainer – take the loan – or bite the bullet and take the distribution and pay the taxAnonymous
There are certain factors here that are not readily available, such as your age, when you plan to retire, how much do yo think you will need for retirement, vs how much you presently have in your retirement. Paying off the home would seem like the ideal thing if getting your home in a free and clear status. some people like that and no matter the argument they feel as if this is what they want to do, if you are one of these types the solution is clear, pay off your mortgage. Remember paying off your mortgage you lose the tax write off of the interest that you presently enjoy. This might be a consideration that you will want to consider. If you decide to keep the mortgage, you should refinance your mortgage to a lower interest rate and since the rate would be lower the payments might be such that you can get a 20- or 15-year mortgage, with just a small increase in your payments. Put the rest in certain bonds, stocks and real estate depending on how you feel about the investment instrument. What interest return on these type instruments would you get if you invested more into these instruments’ vs paying off the mortgage. You investing in stocks, bonds, real estate and others will depend on the risk you take. The older you are the less risk you should take. Make sure that your investment portfolio has some real estate in it, either 2nd trust deeds through a real estate mortgage banker or broker. I used the 1/3 of my total investment amount and moved to less riskier investment items as I got older. It is something like this when you are in a status where you can still earn money, and your investments are 1/3 risky stuff, 1/3 less risky and 1/3 in safe stuff. As I got older, I moved more in the later 2 of the 3 thus into safer investment instruments. I hope this has been of some use to you, good luck. “FIGHT ONAnonymous
Whether the money you take out is pretax or it is from a Roth IRA and you already paid the taxes on it, by withdrawing the money now you are losing the effect of tax deferral on the interest or earnings. For example, if you have $10,000 and can earn 6% per year and pay 25% in taxes, you only earn 4.5% per year in a non-IRA account. After 10 years you’d have $15,529.69. In an IRA account, you get compounding on a higher amount, 6%. After 10 years, paying the 25% tax at the end, you have $15,931.36. If the IRA account is pretax, you have the additional advantage of tax deferral on the principal. So, $10,000 in earnings that are not in an IRA will result in $11,647.27 (I started with $7,500 because I’m assuming 25% in tax immediately), in an IRA where the initial deposit is tax deferred, you’d have $13,431.36, a much larger difference. In your case, it is not a difference between IRA vs. savings, it is IRA vs. borrowing. So, the interest rate to borrow will be substantially more than a “safe” interest rate inn IRA. I’m not sure what the answer is, and it would probably take hours or days of creating spreadsheets and doing all sorts of complex calculations. You’d have to factor your age and estimated life expectancy, whether you plan on taking the minimum distribution in the future (since a withdrawal will lower it) or a fixed higher amount each year, estimated future earnings rates, inflation rates, tax rates, etc. I’m probably leaving out a lot of things that I can’t even think of now. Whatever the answer is, I would be more inclined to doing it if the money was coming from a Roth IRA or an account that is mostly after tax. This way, you only lose the benefit of future pretax compounding. If the money you take out is pretax, you need to take out more to cover the taxes and this is probably a worse option. Before you do anything, I think you should look at your overall financial situation and see what your retirement situation is. Assuming that you aren’t much over 59.5 and don’t smoke, you can easily have 30 years left to live, maybe a lot more if medical advances can detect cancer earlier and perhaps cure it, and we may have the capability to extend lives a lot longer by growing organs in the lab or with the extra-cellular matrix (saw this on the news last night, it is very interesting). So, if you have $50,000 or $100,000 or even $200,000-$300,000, you might need this money to live on and should perhaps keep your car or buy a reliable used car. If you have $1,000,000 or more, then perhaps you can afford to take out $20,000 for a new car. I’m guessing that you don’t have a fortune in your IRA or other retirement accounts because if you were that good at saving you would be able to pay in cash from your savings account without needing a loan – if I’m wrong I apologize.Anonymous
If this is a regular (not ROTH) IRA, then I would say don’t do it. The reason is that taking it out will cause it to be treated as ordinary income, and will be subject to taxes on top of whatever other income you have this year. So, you could end up paying 25% or 28% in marginal tax rate because this is added to all your other income.
If you are close to retirement, it really isn’t a good idea to buy a brand-new car and finance it. Instead, save up for a couple of months, pretend you have a car payment, and put that “payment” into a bank account so you can pay cash for a decent, but used, car that you pay cash with.
Keep your IRA for your retirement. At your age, you are likely to live for another 30+ years, and you really want to stretch that IRA money out for as long as you can.Lauren F