Author Topic: Does it make sense to use a Roth IRA as an emergency fund?  (Read 1717 times)

Kazyan

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Does it make sense to use a Roth IRA as an emergency fund?
« on: March 18, 2019, 11:54:32 AM »
I have an almost-satisfactory emergency fund built up (one more paycheck should do it), but would like for that money to do something while sitting around. Since a Roth IRA allows the original contributions to be taken back out without penalties or taxes, is it a good idea to stash an emergency fund in the form of contributions to a Roth IRA? Would this cause any issues related to contribution limits, for example?

terran

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #1 on: March 18, 2019, 12:03:33 PM »
I think it makes sense when you can't otherwise afford to max all available tax advantaged accounts. There's no sense not using all tax advantaged space while holding an emergency fund in a non-tax advantaged account. The worst thing that happens from keeping your emergency fund in a Roth IRA is that you have an emergency and have to take it out, in which case you're in the same place as if you didn't put it in the Roth IRA in the first place. The best case is that you never have an emergency and you haven't been paying taxes on the income the money produces.

Remember that investment location and allocation are not the same thing. Just because you're keeping your emergency fund in a Roth IRA doesn't mean you should invest your emergency. You should make that decision separately and probably keep it emergency fund portion of your IRA in a money market or bond fund.

You might find this helpful: https://www.bogleheads.org/wiki/Roth_IRA_as_an_emergency_fund

Telecaster

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #2 on: March 18, 2019, 12:17:06 PM »
I personally don't like this, although it isn't really a bad thing.  The downsides are you miss out on the tax free growth, and your taxes become more complicated.

The conventional wisdom is that you should not have your emergency fund in stocks, for the simple reason the stock market could drop at the same time you have an emergency and your funds won't be there when you need them.

I disagree.  I think stocks in a taxable account is a fine place for an emergency fund, with the caveat you should view your available funds as some percentage (like say, 30%) less than the actual balance. 

What will probably happen is that your emergency fund will simply grow to the point where it is quite a bit larger than what you budgeted for originally, and you'll stop thinking about it as an emergency fund, it will just be funds at that point.  It isn't a bad idea to have some taxable accounts anyway.   

robartsd

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #3 on: March 18, 2019, 12:36:36 PM »
I personally don't like this, although it isn't really a bad thing.  The downsides are you miss out on the tax free growth, and your taxes become more complicated.
I'm a big fan of EF in Roth IRA until you're maximizing all tax advantaged accounts. The only possible advantage to taxable accounts is that there is no penalty for using any growth of the assets should they be needed in an emergency. Of course if you can save enough that you run out of tax advantaged space, it is best to allocate taxable savings as an emergency fund first.

Retireatee1

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #4 on: March 18, 2019, 02:24:27 PM »
I prefer a layered approach, with at least 6 months of EF in non-retirement accounts.  Then I might consider the Roth to be the EF after that.  The trouble with the Roth is that while you are working, contributions are severely limited.  So it's easier to get money out than back in.

robartsd

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #5 on: March 18, 2019, 03:15:59 PM »
I prefer a layered approach, with at least 6 months of EF in non-retirement accounts.  Then I might consider the Roth to be the EF after that.  The trouble with the Roth is that while you are working, contributions are severely limited.  So it's easier to get money out than back in.
Sure it's easier to get money out than in, that's why you put in as much as you can - even if you have to put your EF in to fill it up. If you can fill it AND have an EF outside - that's better, but don't use the need for an EF as a reason not to fill an IRA.

therethere

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #6 on: March 18, 2019, 03:41:45 PM »
I think it's a great idea. As long as you have a certain minimum amount available for dire, immediate emergencies (maybe like 1-2k depending on your risk). I started with my Roth IRA as my full emergency fund because I wouldn't be able to fund it otherwise. Luckily I didn't have any emergencies in the past few years, so now I have enough excess that I've been able to hold onto more cash and save in a brokerage fund. But I still got the benefits of the Roth IRA for the early contributions. If you're in the stage of not (or barely) being able to fully max out your tax-advantaged accounts I would consider it your e-fund. 

Even now I consider my Roth contributions as dire emergency or potential downpayment money. I'm just a lot less likely to use it now because I'd raid some other accounts first.

theolympians

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #7 on: March 18, 2019, 06:16:41 PM »
NO, it doesn't make sense.

theolympians

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #8 on: March 18, 2019, 06:23:56 PM »
If you are younger than 59.5 you take a 10% penalty right before it is disbursed to you (Think $1000 on $10,000, not small change that the gov't takes). It is also considered reportable income, so it will be declared as such for tax purposes. Depending on income level, that may bump you into another income bracket.

Don't over-think things. The emergency fund isn't designed to make money, but to be the stash under the pillow if something happens. So let it sit in a bland savings account, it will be readily available when needed.

Use you Roth and Traditional Iras to fund your retirement, not as an atm.

EvenSteven

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #9 on: March 18, 2019, 08:16:55 PM »
If you are younger than 59.5 you take a 10% penalty right before it is disbursed to you (Think $1000 on $10,000, not small change that the gov't takes). It is also considered reportable income, so it will be declared as such for tax purposes. Depending on income level, that may bump you into another income bracket.

Don't over-think things. The emergency fund isn't designed to make money, but to be the stash under the pillow if something happens. So let it sit in a bland savings account, it will be readily available when needed.

Use you Roth and Traditional Iras to fund your retirement, not as an atm.

This isn't accurate. There is no penalty for withdrawing contributions from a Roth IRA. It is not considered taxable income. If you are not going to fill up your IRA space otherwise, holding your emergency fund in your Roth is a good idea.

MustacheAndaHalf

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #10 on: March 18, 2019, 10:24:27 PM »
An example: you put $5,000 in a Roth IRA, and wait.  It grows to $7,000.  If you take out $5,000 there's no taxes or penalties.  But the $2,000 of growth needs to be left in until retirement, or you'll pay a penalty.

ender

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #11 on: March 19, 2019, 06:13:12 AM »
We did this a few years ago, basically borrowed money from our emergency fund to max out our Roth IRAs which we otherwise didn't have money to fully fund prior to the deadline.

At this point my wife and I have close to $80k worth of Roth IRA contributions, which honestly means we could get rid of most of our emergency fund I think. Job loss is the only real emergency I can think of which would really mean we have to withdraw money.

forgerator

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #12 on: March 19, 2019, 07:06:35 AM »
I personally don't like this, although it isn't really a bad thing.  The downsides are you miss out on the tax free growth, and your taxes become more complicated.

I don't think it's the case that taxes become complicated. I withdrew principal twice in 2017 and 2018 from my Roth and as long as you're using some intelligent tax apps like Turbo tax it will report correctly that you owe no taxes. Just an extra couple of questions and screens that I had to answer that's all.

radram

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #13 on: March 19, 2019, 08:17:01 AM »
I have an almost-satisfactory emergency fund built up (one more paycheck should do it), but would like for that money to do something while sitting around. Since a Roth IRA allows the original contributions to be taken back out without penalties or taxes, is it a good idea to stash an emergency fund in the form of contributions to a Roth IRA? Would this cause any issues related to contribution limits, for example?

If I had an emergency without a way to pay for it, I would charge it and pay it back as soon as I could before I took money out of my Roth. It's not even close. Paying even 20% interest for a few years would be less of a loss than removing decades of tax free earnings from a one time removal of Roth money.

I disagree with the coveted investment order folks in this regard(https://forum.mrmoneymustache.com/investor-alley/investment-order/)

I would not fail to max a Roth for 2018 with money in the bank. I would max the Roth, buy a CD with it, and prepare to re-build up my emergency. If I lose my job and are no longer cash flow positive, I can get it back by selling the CD, losing a few months interest. If I don't end up needing it I used a tool I would have otherwise let go to waste.

And congratulations. You are spending less than you earn. That is no small feat. If you think of it, is really is a post for Moustachian People Problems. "I don't know whether to put my money in a place it will be tax free forever, or in a place where I can pay for things I absolutely need."

robartsd

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #14 on: March 19, 2019, 08:23:07 AM »
Accounting for the withdraw of Roth contributions on your taxes is much simpler than accounting for the sell of taxable equities (not that EF allocations should be in equities - but I would generally sell taxable equities before withdrawing Roth contributions).

We did this a few years ago, basically borrowed money from our emergency fund to max out our Roth IRAs which we otherwise didn't have money to fully fund prior to the deadline.
This is exactly what I recommend. Filling out your prior year taxes -> we didn't max our IRA contributions -> no money that isn't emergency fund -> contribute to Roth IRA from emergency fund -> can withdraw Roth IRA contributions if emergency comes up. I do tend to reserve at least one month's expenses because it is much less stressful to operate that way, but beyond that I'm OK with counting Roth contributions as EF if it means more usage of tax advantaged accounts.

thesis

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #15 on: March 19, 2019, 08:51:43 AM »
Especially on these forums, I've seen the growing trend of people foregoing emergency funds entirely or at least believing they are over-rated, but this thinking tends to be more prevalent among high net worth people, many who are already FIRE'd, and I think that makes sense.

But at significantly lower net worths, an invested emergency fund is highly volatile and can impact a person's ability to cover the expenses required by the emergency. This is why it's generally not recommended to invest your emergency fund. It will come down to personal risk, however. More people are comfortable investing that money when they already have loads of investments laying around, but your mileage may vary.

It is true that you can withdraw your contributions to a Roth IRA, but just don't forget that you can't necessarily put that money back. If I have contributed $15,000 in a Roth IRA from previous years and have not contributed any for this year, and suddenly I have some crazy $10,000 emergency, yes, I can withdraw that $10,000 penalty free. However, I can't just put $10,000 back into my Roth later - I'll only be able to put in the contribution limit for the year (currently $6,000), and maybe possibly some for the previous year (if it's before April). The rules here are kind of tricky, you'd have to research this. But I hope the point is clear.

That, in my opinion, is one of the dangers of using a Roth IRA as an emergency fund: you could potentially permanently decrease how much you have in there. Buuuuut, then money is really about living life, so you do what you gotta do. One could argue that the potential foregone growth of un-invested cash out-weighs the risk of this. Damn personal finance, too many options!

I put my EF in a money market account. It earns me a little bit. I feel more secure this way. My Roth IRA is the emergency fund for my emergency fund, ha.
« Last Edit: March 19, 2019, 08:56:13 AM by thesis »

StarBright

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #16 on: March 19, 2019, 08:57:54 AM »
I prefer a layered approach, with at least 6 months of EF in non-retirement accounts.  Then I might consider the Roth to be the EF after that.  The trouble with the Roth is that while you are working, contributions are severely limited.  So it's easier to get money out than back in.

^ this is the approach that we have currently settled on. Except instead of 6 we basically keep 4 months liquid EF.  I don't max my 401k for various reasons including cash flow, but when we have extra it goes to our Roths.

I have had a Roth for almost 20 years at this point and it has been the gift that keeps on giving. I used 10k towards my first house purchase, and we will also use it as our back up for our kids' college for whatever we can't cash flow (you can use it penalty free to pay for education).

I was honestly thinking this morning how much I love Roth IRAs and was thinking of posting about it (that's how you know you are a nerd) so was happy to see this post :).

EvenSteven

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #17 on: March 19, 2019, 09:25:29 AM »
Especially on these forums, I've seen the growing trend of people foregoing emergency funds entirely or at least believing they are over-rated, but this thinking tends to be more prevalent among high net worth people, many who are already FIRE'd, and I think that makes sense.

But at significantly lower net worths, an invested emergency fund is highly volatile and can impact a person's ability to cover the expenses required by the emergency. This is why it's generally not recommended to invest your emergency fund. It will come down to personal risk, however. More people are comfortable investing that money when they already have loads of investments laying around, but your mileage may vary.

It is true that you can withdraw your contributions to a Roth IRA, but just don't forget that you can't necessarily put that money back. If I have contributed $15,000 in a Roth IRA from previous years and have not contributed any for this year, and suddenly I have some crazy $10,000 emergency, yes, I can withdraw that $10,000 penalty free. However, I can't just put $10,000 back into my Roth later - I'll only be able to put in the contribution limit for the year (currently $6,000), and maybe possibly some for the previous year (if it's before April). The rules here are kind of tricky, you'd have to research this. But I hope the point is clear.

That, in my opinion, is one of the dangers of using a Roth IRA as an emergency fund: you could potentially permanently decrease how much you have in there. Buuuuut, then money is really about living life, so you do what you gotta do. One could argue that the potential foregone growth of un-invested cash out-weighs the risk of this. Damn personal finance, too many options!

I put my EF in a money market account. It earns me a little bit. I feel more secure this way. My Roth IRA is the emergency fund for my emergency fund, ha.

This is true, which is why there are some important things already mentioned up thread. It is wise to store the emergency fund in your Roth IRA, if that Roth space would not otherwise be filled. So you are not actually loosing any Roth space if you do need to withdraw, you are only gaining space if you don't.

Regarding volatility, also mentioned up thread is that money in a Roth IRA doesn't need to be invested in equities. You can keep your emergency find in your Roth in a CD or money market account. Which assets to keep your emergency fund in is a different decision from which account type to keep it in.

thesis

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #18 on: March 19, 2019, 09:39:52 AM »
Regarding volatility, also mentioned up thread is that money in a Roth IRA doesn't need to be invested in equities. You can keep your emergency find in your Roth in a CD or money market account. Which assets to keep your emergency fund in is a different decision from which account type to keep it in.

Really good point, I always forget about this :)

robartsd

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #19 on: March 19, 2019, 01:13:13 PM »
Regarding volatility, also mentioned up thread is that money in a Roth IRA doesn't need to be invested in equities. You can keep your emergency find in your Roth in a CD or money market account. Which assets to keep your emergency fund in is a different decision from which account type to keep it in.

Really good point, I always forget about this :)
Forgetting about this is a very common problem; which is why those of us who understand are so diligent in expressing "Use Roth IRA as EF if you otherwise can't afford to max your IRA". Banks offer Roth (and traditional) IRA savings accounts and CDs (when you no longer need to use Roth as EF, you can rollover to an investment brokerage), Investment Brokerages offer Money Market funds in every account type I have seen. There is no realistic reason to forego IRA contributions in order to have an emergency fund - just use Roth IRA contributions as an emergency fund if needed.

Telecaster

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #20 on: March 19, 2019, 01:52:34 PM »
Regarding volatility, also mentioned up thread is that money in a Roth IRA doesn't need to be invested in equities. You can keep your emergency find in your Roth in a CD or money market account. Which assets to keep your emergency fund in is a different decision from which account type to keep it in.

Really good point, I always forget about this :)
Forgetting about this is a very common problem; which is why those of us who understand are so diligent in expressing "Use Roth IRA as EF if you otherwise can't afford to max your IRA". Banks offer Roth (and traditional) IRA savings accounts and CDs (when you no longer need to use Roth as EF, you can rollover to an investment brokerage), Investment Brokerages offer Money Market funds in every account type I have seen. There is no realistic reason to forego IRA contributions in order to have an emergency fund - just use Roth IRA contributions as an emergency fund if needed.

Agree with your points.  The only wrinkle is that if you go this way, you don't want your Roth to be your emergency fund forever.  The reason is that the advantage of the Roth is tax free growth, so you want stuff that grows in the Roth.   

But to reiterate your point, at least you are filling up the tax-advantaged space, which is better than not filling it up.   

seattlecyclone

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Re: Does it make sense to use a Roth IRA as an emergency fund?
« Reply #21 on: March 19, 2019, 03:38:50 PM »
Agree with your points.  The only wrinkle is that if you go this way, you don't want your Roth to be your emergency fund forever.  The reason is that the advantage of the Roth is tax free growth, so you want stuff that grows in the Roth.   

But to reiterate your point, at least you are filling up the tax-advantaged space, which is better than not filling it up.   

Even if you never expect to be able to max out all your retirement accounts and therefore have your emergency fund in Roth forever, it's still better to get your 1% interest from a CD not taxed in a Roth rather than taxed outside. :-)

But sure, if you do get to the point where your retirement accounts are maxed out, take the opportunity to put your lower-return emergency fund outside of your IRA and reallocate your IRA into more profitable investments.