Roth IRA as emergency fund

[engineeringFIRE]

Hello! I've been reading these forums for awhile now, but this is my first time posting.  I'm fairly young, 25, and not at a point where I'm able to save much more than the amount I'm allowed to contribute to tax-advantaged accounts (401K, IRA, & HSA).  I have cash equal to 2 months of living expenses, and I have contributed another 4 months of living expenses to my Roth IRA.  From my understanding, I can withdraw contributions from a Roth IRA (opened less than 5 years ago) tax and penalty free.

My strategy is to max out retirement & HSA accounts before adding any more cash to my after-tax emergency fund, with a plan to withdraw from the Roth IRA if a large emergency happens. I have my Roth IRA emergency assets invested conservatively to prevent a loss from withdrawing in a bear market.  Once I've built an appropriate after-tax emergency fund, I'll invest the Roth IRA fully into VTSAX. Do you see any holes in this strategy? 

[Monkey Uncle]

Seems like it ought to work.  But if you have the money invested conservatively no matter where it is parked, I see no real advantage to having it in a Roth IRA vs. a savings account or taxable money market account.  I suppose there is a tax advantage to parking it in a Roth, but at the rate cash is earning these days, it probably won't make an appreciable difference.

[terran]

Yes, I think it makes sense to consider Roth contributions as your emergency fund if you can't max out your tax advantaged accounts and also save an emergency fund. Worst case scenario is you have to remove the money for an emergency which is no worse than not having put it in in the first place. See: https://www.bogleheads.org/wiki/Roth_IRA_as_an_emergency_fund

You may want to consider putting the amount you consider your emergency fund in something save (bonds or your brokerage's core/cash position) and not considering it as part of your asset allocation.

[SwitchActiveDWG]

Your strategy seems solid to me, assuming your current marginal tax rate is low.

[Mustache ride]

Seems like it ought to work.  But if you have the money invested conservatively no matter where it is parked, I see no real advantage to having it in a Roth IRA vs. a savings account or taxable money market account.  I suppose there is a tax advantage to parking it in a Roth, but at the rate cash is earning these days, it probably won't make an appreciable difference.

The benefit is having it in the Roth IRA for the long haul. If you don't contribute to an IRA for the year that opportunity is gone forever. Even if he earns peanuts in the short-term until he builds up the e-fund, it's still worth it to keep that money sitting in there and switching it to equities to grow for decades. Worst case scenario he has to pull it all out and he loses a couple percent compared to it being in an after-tax account or cash. The upside greatly exceeds the downside risk IMO.

[engineeringFIRE]

Yes, I think it makes sense to consider Roth contributions as your emergency fund if you can't max out your tax advantaged accounts and also save an emergency fund. Worst case scenario is you have to remove the money for an emergency which is no worse than not having put it in in the first place. See: https://www.bogleheads.org/wiki/Roth_IRA_as_an_emergency_fund

You may want to consider putting the amount you consider your emergency fund in something save (bonds or your brokerage's core/cash position) and not considering it as part of your asset allocation.

Thanks for the link! Good explanation, and I'm glad to hear that it should work out.   

[ThatGuy]

Seems like it ought to work.  But if you have the money invested conservatively no matter where it is parked, I see no real advantage to having it in a Roth IRA vs. a savings account or taxable money market account.  I suppose there is a tax advantage to parking it in a Roth, but at the rate cash is earning these days, it probably won't make an appreciable difference.

The benefit is having it in the Roth IRA for the long haul. If you don't contribute to an IRA for the year that opportunity is gone forever. Even if he earns peanuts in the short-term until he builds up the e-fund, it's still worth it to keep that money sitting in there and switching it to equities to grow for decades. Worst case scenario he has to pull it all out and he loses a couple percent compared to it being in an after-tax account or cash. The upside greatly exceeds the downside risk IMO.

+1

[therethere]

Yup. This is how I considered my e-fund until I was about 30 and had more cash. It's also a good deterrent to using the emergency fund if you don't absolutely have to. If you have 5k in a savings account you can easily be tempted to spend it. In a Roth IRA you'd think twice before withdrawing and spending the money. And it would take a few days to get. That being said I'd recommend keep a buffer in your checking account to account for all your "cash" monthly expenses (rent, loan payments, etc) as a mini-efund. Eventually get that up to a month of floating expenses.