You should avoid using retirement funds to buy a car. That's because you may incur penalties during withdrawal and pay more taxes. Your investment earnings may also be lower compared to if you had not withdrawn from your retirement accounts. However, if you have to buy a car with an IRA, you need to learn how to do it right so you minimize the consequences of doing so.
Buying a Car With an IRA
Is using IRA for a car purchase smart? Well, it depends. Sometimes, using retirement funds to buy a car may be the best available option. You can borrow up to 50 percent of your 401(k)’s vested balance or $50,000, whichever is lower.
You will then have five years to pay back the money into your account. If you don’t pay your loan on time, you will pay penalties and taxes. Since the 401(k) loans are interest-free, you will save money in the long term by using them to pay for your car. But, of course, everything depends on your financial situation.
It makes sense to use your retirement funds to buy a car when:
Buying a Vehicle Will Saddle You With a High-Interest Loan
If you are like most Americans, you probably carry debt of some kind. A typical American has an average of $92,727 in student, home equity line of credit, auto and personal loans.
Auto loans are not a joke. According to research by LendingTree, to afford a new car, you may need to borrow as much as $34,635. And even if you opt for a used car to save money, you still need to borrow an average of $21,438. Then, depending on your credit score, you will have to pay an interest rate of anywhere from 5.49 to 22.66 percent.
Auto loans tend to be associated with high interest rates. So, if you are struggling with other consumer debts, it may make better sense to borrow against retirement funds to buy a car.
You Are Over 59 1/2 Years Old
If you are getting older and do not want to risk getting into retirement with debt, you should consider using some of your retirement funds to purchase a car. For example, if you are 59 1/2 years old and older, you can buy a car with an IRA without paying the 10 percent early withdrawal penalty.
Your Roth IRA Has Existed for at Least Five Years
A Roth IRA can also help you realize your dream of buying a car. The account is usually funded by after-tax dollars, which means that your withdrawal will not cause you to pay more taxes. However, your Roth IRA must meet the five-year rule.
The five-year rule states that you can only withdraw your earnings from your Roth IRA tax-free if the account in question is at least five years old and you are over 59 1/2 years old. However, if your Roth IRA is five years old, you can still access money if you are totally and permanently disabled and need a suitable vehicle. If you withdraw before the waiting period lapses, you will pay a penalty of 10 percent for early withdrawals.
Whereas you need to meet specific conditions to withdraw your Roth investment earnings, you can withdraw some of the monies you contribute at any time. And you won't incur any penalty or need to pay taxes. But if the amount is less than what you would need to buy a suitable vehicle, it’s not worth it.
Youth Is in Your Favor
You may still want to buy a car using your retirement funds even if you are still young and your Roth IRA has existed for a short time. In that case, consider whether it makes financial sense to do so after factoring in all the expenses.
The longer your money stays within your retirement accounts, the more it grows. So, withdrawing some of your retirement monies could set you back financially a few years.
However, if you have a secure job, lots of working years ahead of you and lots of high-interest consumer debt, sit down and do the math. If reducing your debt by using your retirement funds to buy a car is the financially better option, then go ahead.
The IRA Withdrawal Process
Below are the steps you should take if you want to buy a car with an IRA:
- Shop around for the vehicle you want and select the one that meets your criteria.
- Inquire from your financial lender or car dealership concerning the total cost of buying the vehicle. Be sure to use various down payment scenarios while coming up with the financing plan.
- Reach out to a tax adviser and consult on the cost of using a traditional auto loan vs. borrowing or withdrawing money from your retirement accounts. Be sure to consider the taxes and penalties you will incur when making comparisons.
- If it makes financial sense to get money from your IRA, contact your IRA custodian and fill in the IRA withdrawal form with the required details, including the amount you need.
- Deposit the amount you need into your car purchase account.
- You can also set up a monthly withdrawal arrangement that directs money to your car-buying account each month.
- Buy your car.
Everyone’s situation is unique. While it may not be wise for other people to buy cars in cash using retirement funds, doing so may work for you. Your retirement funds can help you buy a suitable vehicle if you are eligible for withdrawals or are willing to take a few risks. Therefore, it would be wise for you to consult a tax adviser before making the final decision.
- Microsoft: Is Car Loan Interest Tax Deductible?
- Experian: Should I Finance or Pay Cash for a Car?
- Experian: Average U.S. Consumer Debt Reaches New Record in 2020
- LendingTree: Average Car Payment | Loan Statistics 2021
- LSFCU: Borrowing Against Your 401(k) – is it ever a good idea?
- Business Insider: What Is the Roth IRA 5-Year Rule? Important guidelines for withdrawing IRA earnings
- H&R Block: Traditional & Roth IRAs: Withdrawal Rules and Early Withdrawal Penalties
I hold a BS in Computer Science and have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.