Car Financing Strategy Can Backfire
Q. I am thinking of taking out a home equity loan in order to purchase a new car. My thought is that since home equity mortgage interest is deductible on my taxes, while consumer interest is not, I am better off, tax-wise, getting a deduction for loan I will invariably have to get to buy this car. Does my plan make sense, and is it permissible?
--C.Y.B.
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A. Taxpayers are allowed to deduct the interest on mortgages up to $1 million for the purchase, construction or improvement of a principal or second home. They are also allowed to deduct the interest on home equity mortgages up to $100,000 regardless of how that money is used. Thus, assuming that you would not exceed the $100,000 limit, the law would allow you to deduct the interest you pay on a home equity loan whose proceeds were used to purchase a new car.
That said, let’s examine whether your plan makes good financial sense. Certainly by purchasing your car with the proceeds of a home equity loan, you are taking advantage of virtually the only deductible loan remaining for the average taxpayer. So by financing your car with home equity proceeds, you are better off than making traditional car payments to a credit union, bank or auto financing company.
However, unless you’re financially disciplined, your strategy could backfire, leaving you in a worse financial position than when you started. How? If it takes you longer to pay off your home equity loan than it would take to pay off a car loan. You can, for example, refinance your house for up to 30 years. But why would you want to be paying interest on a car that has long since gone to heaven? If you want to finance your car with a home equity loan, you’re best advised to repay that loan in three to five years, the same length of time a traditional car loan would require. This way you can be completely sure that you are getting the full benefit of the strategy you have thought so long and hard about.
Another risk is that Congress might restrict or eliminate the home loan deduction.
No Estate Taxes Owed if Mom Not Policy Owner
Q. I purchased an insurance policy on my mother’s life several years ago, naming myself as beneficiary and her as the successor owner in the event I predeceased her. She died several months ago and I received the death benefits. Now I’ve been told that because she was a contingent owner on the policy, the entire proceeds should be included in her estate for estate tax purposes. Is this true? Your answer can make a big difference on any taxes the estate might owe.
--S.M.K.
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A. According to our advisors, so long as your mother never owned the policy, its proceeds do not have to be included in her estate. However, if your mother had originally purchased the policy and given it to you while reserving the right to take it back in the event you predeceased her, then the proceeds would be included in her estate because she had reserved a reversionary right on the policy. From your account of your facts, it would appear this does not apply to your case.
No Minimum Age Set for Opening an IRA
Q. At what age may an Individual Retirement Account be opened for a child? Does the child have to be employed to qualify for one?
--R.H.
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A. There are no restrictions on the youngest age at which a taxpayer may open an IRA. However, the government requires that taxpayers contributing to IRAs have earned income for the year in which the account is opened. Taxpayers may contribute their total earnings to tax-deferred IRA up to a maximum of $2,000 per year. The laws covering after-tax contributions to an IRA are no different for youngsters than for adult taxpayers.
Clearly, given the “magic” of interest compounding, an IRA held for 40 years or more can generate terrific tax-deferred earnings. However, before you encourage your youngster to open such an account, be sure he or she really has no more important use for the money than to save for his or her retirement. Remember, there are considerable penalties for early withdrawal of IRA funds--penalties that can undermine all the tax advantages of such an account. If he or she is so inclined, your youngster has until April 15 of this year to open an account for 1995.
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or send e-mail to carla.lazzareschi@latimes.com
