Considering buying a new car in retirement? Even with a 25% tariff on many vehicles, and despite General Motors' pledge not to raise prices on its new cars, you might still be wondering if it's the right move.
While avoiding price hikes is never a reason to purchase a big-ticket item, if you are in the market for a new car, how you purchase it will make a big difference in the overall cost of your new ride.
After all, retirees have two options when buying a new car: finance it or buy it outright.
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Financing it means taking out a loan from a bank or lender and paying interest over the life of the loan. Buying it means drawing down from your retirement savings, either from a tax-advantaged or non-tax-advantaged savings account.
Which option makes the most sense requires some back-of-the-envelope calculations and in-dealership negotiations, says Denny Artache, president and CEO of Artache Financial Group.
While some financial gurus bemoan the idea of buying a new car because it loses about 10% of its value as soon as you drive it off the lot, if you can get a deal, that argument goes out the window, Artache says.
Plus, buying new gives you peace of mind. With a new vehicle, you are less likely to have the car break down and cost you money for the next five to seven years, beyond the normal maintenance.
“Every time you buy a car below MSRP and are buying something at a 20% discount, you are ahead of the game,” says Artache. “You have to be smart about the rates.”
The case for financing your new car
Financing a new car makes sense when you have a really good credit score and get a deal such as 0% interest for 60 months. Alternately, financing makes sense when the interest rate is low enough that it is cheaper than taking the money out of your retirement savings and paying taxes on the withdrawal.
Let's say you want to purchase a new car for $40,000 at an APR of 2% for five years. You would pay $2,066.63 in interest. At 3% your interest would be $3124.86. (The calculation does not include state and sales tax, title, registration and other fees.)
If you took out $40,000 from your 401(k) and you are in the 12% tax bracket, you would pay $4,800 in taxes, plus that money would lose the compounding effect of staying invested in your 401(k). If you are in a higher tax bracket, the hit will be even more.
When it doesn't make sense to finance
If you have a low credit score, will pay a high interest rate on your car loan, and are in the 12% tax bracket, then financing may not be the best option. Take that $40,000 car loan over five years, but at an APR of 5%. You would end up paying interest of $5290.96, excluding sales and state taxes and title, registration and other fees. At 7% that goes to $7522.88.
The tax on withdrawing $40,000 from your 401(k) in the 12% tax bracket would be way less at $4,800. If you have a Roth 401(k), the withdrawals are tax-free, but you will lose the compounding effect if you take a drawdown.
When it doesn’t make sense to buy a new car
While buying a new car will give you that peace of mind, it doesn’t make sense to spend money you don’t have, especially if you are on a fixed income.
If you can’t afford a new car, Atache says to consider purchasing a used one. Instead of spending $40,000, buy one for $20,000 and hire a trusted mechanic for $500 to ensure the car will last for 50,000 to 100,000 miles without breaking down.
After all, you may not drive as much as you did when you were younger and won’t put as much wear and tear on your vehicle.
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