Is this a good use of Roth IRA?

[DustyMom]

A relative is asking for advice in paying off a car loan. I want to make sure I don't steer them wrong. They just financed a car to get the offered rebate but want to pay it off ASAP. They have a smallish Roth IRA in addition to a much larger Traditional IRA. I'm thinking the Roth IRA makes more sense for drawing the funds so as not to push them further into the 22% tax bracket. They are currently 60-ish (not yet at the point of worrying about IRMAA), basically retired but working part-time, mostly for benefits and extra spending money while drawing on the TIRA. Would you say the Roth IRA is the best option?

 

[Kabowest]

What is the interest rate on the car loan? If it is low then it may make more sense to leave the money in the Roth, potentially earning more than the cost of the loan. They could also consider funding the monthly payments from the Roth account.

 

[RetiredHappy]

It depends on the size of their Traditional IRA, their income, Roth IRA, auto loan and auto loan interest rates. There are too many variables to make a recommendation.

 

[DustyMom]

The Roth is probably just big enough to fund one year of desired spending if that was the only source of income. TIRA is 10x that. In about five years a decent-sized pension will kick in, as well as two SS benefits, which should probably provide enough income for their needs. That Roth was never going to be a major income source at that size so I figured why not use it for a large non-recurring expense? I don’t know what the interest rate is but I could ask.

 

[DustyMom]

Also, the car loan payoff would probably use up about a quarter of the Roth. Like I said, it is pretty small.

 

[VanWinkle]

I would use other savings if available as the Roth is a great tax free account and many
pay taxes on their IRA just to get the money into their Roth IRA. Would I ever do what you are proposing,
only as a last resort. I'm not saying you are wrong, just better ways if available.

 

[skipro33]

Many auto manufacturer financing has prepay penalties. They discount the car if you borrow from them to finance it, catching their profit through interest. It would be sad if they went through all the work to draw from their ROTH, only to discover they have a prepay penalty on the auto loan.

 

[RetiredHappy]

Many will view Roth as sacred and use it as a last resort. Why use it when you have other sources of income to pay off the loan? Also, if car loan amount is small, is there really a need to pay if off?

 

[DustyMom]

No other savings are available. It is either the Roth, the Trad IRA and pay taxes or pay the interest on the loan.

 

[Kings over Queens]

Based on the comment "they financed the car to get the rebate" I get the sense that your relative has enough income to cover the car payment as planned, or savings on the sidelines to payoff the loan without touching anything else.

If it were me they came too I'd have asked a lot more questions to understand what they are trying to achieve, and why. The first thing I'd need to know is how much interest is going to be paid over the life of the loan, this way I have the number they are trying to save by paying it off. Then I'd need to know how the Roth is invested. For all anyone knows they money in the roth is invested in a low interest money market and using those funds will save them money.

One thing I've become sensitive to as I approach FIRE is cash flow, and I'm willing to let perfect be the enemy of good. If I have to pay a little interest, it'll be OK. My investments overall outperform whatever interest is being charged.

 

[RetiredHappy]

No other savings are available. It is either the Roth, the Trad IRA and pay taxes or pay the interest on the loan.

What is the interest on the loan? If I want to pay it off, I will pull from Traditional IRA first if there is no taxable account to pull from.

 

[Kings over Queens]

No other savings are available. It is either the Roth, the Trad IRA and pay taxes or pay the interest on the loan.

1. How much moeny will they save by paying off the loan?
2. How much money will they pay in taxes by drawing down the TIRA?
3. How much investment gains will be lost by drawing down the TRIA?
4. How much investment gains will be lost by drawing down the Roth?

 

[JBTX]

So many variables here and so little information it is impossible to make a recommendation. My first thought is if the auto loan isn’t too high I’d just keep it.

So if they have no income and no liquid savings, how are they paying their day to day expenses?

 

[Spock]

New this year is car loan interest can be tax deductible if they meet all the requirements (ex. assembled in the US).

 

[JBTX]

Let’s extrapolate here:

Roth is 4 times car purchase price
Roth is about 1 year expenses

Let’s assume car was $30,000, and Roth is $120,000, thus traditional is $1.2 million

They will eventually have social securities and 2 pensions, so down the road seems likely they will be at least in 22%, especially with some eventual RMDs.

If there is some compelling reason to keep income low, such as ACA subsidies, then perhaps use Roth. Otherwise if traditional comes out at 22%, that’s the amount it will eventually come out anyway, so use traditional.

I would only do this if the interest rate were relatively high, maybe 5% or more.

 

[Koolau]

I'm strongly considering taking some Roth money this year. If I do, it will be the first time. If I do so, it will ONLY be to prevent triggering IRMAA.

I need some money and I'm close to IRMAA limits. What WILL I do in my late 70s??

To pay off a car loan in early '60s. No way!

 

[pb4uski]

What is the interest rate on the car loan? What is the Roth invested in and what does it yield? Why are they so keen to pay off the car loan? Are they unable to make the car loan payments from cash flow?

 

[pb4uski]

No other savings are available. It is either the Roth, the Trad IRA and pay taxes or pay the interest on the loan.

You said that they financed the car to get the rebate. If not for the rebate, then how would they have bought the car?

 

[junkanoo]

Let’s extrapolate here:

Roth is 4 times car purchase price
Roth is about 1 year expenses

Let’s assume car was $30,000, and Roth is $120,000, thus traditional is $1.2 million

They will eventually have social securities and 2 pensions, so down the road seems likely they will be at least in 22%, especially with some eventual RMDs.

If there is some compelling reason to keep income low, such as ACA subsidies, then perhaps use Roth. Otherwise if traditional comes out at 22%, that’s the amount it will eventually come out anyway, so use traditional.

I would only do this if the interest rate were relatively high, maybe 5% or more.

We really need the interest rate and any penalties to get out of the loan to understand this. However, I appreciate the SAT-like analysis. They are working ostensibly for Health Care benefits so ACA isn't the issue (at least at this point). Also, in their future, their Roth account might be really helpful in avoiding IRMAA cliffs or staying out of the next marginal tax rate ... so I don't think I would touch their Roth and lose that future leverage ... particularly as that leverage can't come from their non-existent taxable account.

If the worse is that pulling from the T-IRA means that they are only going further in the 22% bracket ... it's not a big deal.

 

[pb4uski]

^^^ It depends. It wouldn't make sense to pay 22% now if once they retire they will have headroom for withdrawals in the 12% tax bracket.

What I don't get is if they are in the 22% bracket, why can't don't they just make the car loan payments. And why don't they have any savings other than IRAs?

ARE THEY OVER 59-1/2 AND NOT SUBJECT TO THE 10% EARLY WITHDRAWAL PENALTIES?

If not, do they have records of contributions that they have made?

 

[JBTX]

^^^ It depends. It wouldn't make sense to pay 22% now if once they retire they will have headroom for withdrawals in the 12% tax bracket.

What I don't get is if they are in the 22% bracket, why can't don't they just make the car loan payments. And why don't they have any savings other than IRAs?

ARE THEY OVER 59-1/2 AND NOT SUBJECT TO THE 10% EARLY WITHDRAWAL PENALTIES?

If not, do they have records of contributions that they have made?

So from my “SAT math” I figured annual expenses are about $120k. Presumably whatever part time income they have goes towards that and the incremental cost of the auto comes out of savings.

They are about 60, and will be taking SS and 2 pensions in about 5 years. OP states pension + SS will cover expenses, so it is over $120k, and likely puts them in the 22% rate going forward.

As it stands they are already in the 22% and will stay in the 22% rate (or very close) indefinitely going forward, and that’s the rate any IRA withdrawals will come out. Thus I don’t see why they’d worry about taking money out now at 22% when that’s where they will likely be for many years to come.

 

[rk911]

How were they planning to buy the car for cash before they changed their minds? Do they have the cash without raiding the Roth? If no then the Roth makes sense to me.

 

[junkanoo]

So from my “SAT math” I figured annual expenses are about $120k. Presumably whatever part time income they have goes towards that and the incremental cost of the auto comes out of savings.

They are about 60, and will be taking SS and 2 pensions in about 5 years. OP states pension + SS will cover expenses, so it is over $120k, and likely puts them in the 22% rate going forward.

As it stands they are already in the 22% and will stay in the 22% rate (or very close) indefinitely going forward, and that’s the rate any IRA withdrawals will come out. Thus I don’t see why they’d worry about taking money out now at 22% when that’s where they will likely be for many years to come.

Agreed. However, 120K in income (assuming expenses = income) wouldn't trigger the 22% bracket, so their T-IRA withdrawal probably more like 120K plus their part-time jobs adding another 30K or so. But, whatever the T-IRA withdrawal is to cover expenses ... it ain't light. And if they aren't able to lower their spending now, I'm also not seeing how that's happening with a "decent sized" pension plus two SS in their future filling up their Ordinary Income bucket. So ... 22% is their future. YMMV.

 

[DustyMom]

OK, I have gotten some additional info, if this helps.

• Loan interest rate: 6.5%
• Loan amount: about $33k. (total interest just under $6k)
• They assure me there is no early payoff penalty
• Roth Balance: about $120k, invested in total stock market index
• T-IRA balance: about $1.1M, invested in total stock market index/Int'l index/Money Market
• When pension and SS kicks in, probably just under $100k per year
• No significant savings other than Roth and T-IRA
• $40k from part-time work, mostly to pay for medical/dental/vision (retiree plan, not ACA)
• They hit the 22% bracket this year, mostly due to T-IRA withdrawal to pay for new roof
• I don't see that IRMAA or 24% bracket will ever be a danger
• 2025 taxable income somewhere around $120k (and that is with the approx $20k w/d to pay for roof)

 

[RetiredHappy]

Can they afford to continue to make car loan payments until they are fully paid off?

Presumably their portfolio makes more than 6.5% per year, then there is no financial incentive to pay off the car loan early.

The other side of the coin is that they should keep the growth of their Traditional IRA growth under control otherwise comes RMD time, they will end up in higher tax bracket, IRMAA and NITT. They may want to do Roth conversion now instead of paying off the auto loan.