It can be tempting sometimes to draw down your retirement accounts to pay for shiny objects, like a new car. After all, retirement can seem so far away! Sometimes you might have no other option than to raid your retirement, if you are in a tight spot with your cash flow and your car gives out. Raiding your retirement can have serious ramifications, however, both in terms of actual cash penalties and lost opportunity cost.
Loss of Retirement Savings
If you take out your retirement savings to buy a car, you are trading in your future for the present. Money you withdraw from your retirement savings now won't be around when you need it in the future. Even worse, the money you use now will no longer be invested, depriving you of future growth. Unless you have a large pension waiting for you in retirement, it can be difficult to replace that missing money once you stop working.
A car is a depreciating asset, meaning its value goes down every year that you own it. By withdrawing retirement savings to purchase a car, you are swapping an appreciating asset -- your retirement account -- for a depreciating asset. The difference can be dramatic. If you can earn a 10 percent return in your retirement account, your money will roughly double every seven years. If you use $20,000 of your retirement savings to buy a car, you are missing out on the future growth of that investment. If you are 30 years old, by the time you are 65 that $20,000 could turn into $562,000 or more.
Any distribution from a retirement account is taxable as ordinary income, with the sole except being a Roth account. If you plan on raiding your traditional IRA or 401(k) plan, you must report your withdrawals when you file your income tax. If you don't have extra cash in your accounts to pay the taxes -- and you probably don't if you need to tap your retirement to buy a car -- you'll have to withdraw an even larger amount in order to pay the taxes.
Unless you are already retired, you'll usually have to pay an additional penalty to access your retirement accounts. The IRS levies an early distribution penalty of 10 percent on withdrawals before age 59 1/2. While there are a few limited exceptions, buying a car is not one of them.
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