Roth IRA question

[eriksonr]

I've recently taken a more mustachian approach to my finances/investing.  I have a two part question regarding a Roth IRA:

First, I've decided to maintain an emergency fund in case of life's surprises.  However, I hate to see the money sitting in a savings or money market account with a nominal interest rate.  Would I be better off holding the money in a Roth IRA knowing that I could withdraw my contributions without penalty?

Second, if I proceed with this course and make a withdrawal of my contributions, will I be able to repay the withdrawn contributions without affecting my annual limits?  For example, If my Roth IRA grows to $15K and I need to unexpectedly withdraw $10k of my own contributions, will I be able to repay the withdrawn amount and still be able to add the $5K annual limit?  Thanks in advance for any tips.

[anitalala]

I'm very interested in this too.

[StaceStache]

You can't repay the withdrawn amount AND contribute the $5,000 annual limit. It doesn't matter where the $5,000 comes from, that's all you can put into the Roth for the year.

I wouldn't have a Roth as my ONLY source of emergency money - I'd still keep at least a bit of cash (even if it's relatively a small amount - enough to cover "minor" emergencies), if only to avoid any paperwork/hassle you will have to go through to tap the Roth.

[arebelspy]

Essentially you don't "repay" a withdrawal from a Roth.  It's not a loan, like some 401k loans and such.  You can continue contributing later (to the max of - currently - 5K/yr), but you don't ever repay what was taken out.

[foodguy]

If you tap a Roth for emergency reasons, that money you withdraw can no longer earn interest.  Say you withdraw $5000 of your contributions for an emergency and still have 20 years left to invest.  Assume a modest 6% rate of return, that withdrawal cost you $16000 in future dollars.  At 8% and 30 years it cost you $50000 in future dollars.  In essence you are financing your future because of now.

Call me anti-mustachian for not viewing a Roth as an emergency fund, but $50000 in future dollars, even inflation adjusted, isn't worth a short-term oversight.  I'd consider tapping the fund if the crapola hit the spinning rotary device on the ceiling, but only as a true and desperate last resort.

[Rich M]

The caveat of a Roth is that it needs to be there five years.  So if you use it as an emergency fund, it's not really liquid for 5 years without penalty.

[Chris]

It seems as though your prime concern is where to park your emergency fund. From the replies above, you can see that a Roth isn't a great place for that (though they are great!).

You first need to decide what this emergency fund is for and how big you need it be. Then you can decide how to store this money in a way you can easily get to it.

Things to consider for an emergency fund:

1) Liquidity - You probably don't need the money to be ready-at-hand, assuming your credit card has a high enough spending limit. You just need to be able to get the money before your credit card bill is due. 
2) Stability - If it's called an "emergency fund", it had better not be very volatile; the investment might tank just when you need it. Also, you probably don't want to divert resources to top off the emergency fund in down months.
3) Return - This is the least important of the three, but I understand your gripe about low-interest savings accounts. You might consider laddering savings bonds or CDs instead.

[MEJG]

Yes the Roth has to sit there for 5 years, and yes you cannot make catchup repayments into the Roth if you need to pull something out.

The question becomes Risk and Risk tolerance.  I don't think anyone should start a Roth as an efund and not have a back up in those first five years.  However, if you have your finances stable, your costs low and like MMM proposes have some flexibility so that if SHTF you could tighten down your costs + pick up some extra work in a month where an emergency happened I think using a Roth this way is a viable option.

To me this means debt payed off (maybe mortgage left), a sinking fund for irregularly irregular costs, and the ability to pay for regularly irregular costs already worked into your yearly plan.  I guess I think this works mostly for people in MMM like retirement or close to being there.

How often outside of irregularly irregular costs (water heaters have a life of 10-12 years, cars will probably need to be replaced around 200,000 mi) does an emergency happen???  Sure we all know someone who has had something happen, but I bet we also know a lot of people who haven't had anything happen.  So what are the actual risks and where is your risk tolerance?  Any money you use for efunds that you actually pull out and use is losing you future return.

I think CD ladders are another great option, especially when CD rates are decent (at least keeping up with inflation). 

Disclosure:  I'm not using my Roth as an efund yet because I'm not in a finically stable position.  We'll be working on a liquid (savings account at Ally) 3 month fund and then move towards either a CD ladder, or save for a down payment because we want to own a home and that will allow us to utilize springy debt.

[arebelspy]

The caveat of a Roth is that it needs to be there five years.  So if you use it as an emergency fund, it's not really liquid for 5 years without penalty.

Not true, only if you're pulling out earnings, but first in first out policy of Roths means you withdraw contributions first, which are never subject to the penalty, even within the first 5 years.

[MEJG]

I love this new forum, it encourages me to look things up and double check things I thought I knew.

Arebelspy is right, http://en.wikipedia.org/wiki/Roth_IRA  Contributions can be withdrawn at anytime.  So $5,000 per year you max out is available to you at any time if a Roth works for your particular situation as an efund.

[Ben]

How "emergency" is your emergency fund? Is it unexpectedly replace-a-fuel-pump and buy-a-new-fridge emergency, or major life circumstance (job loss, major illness) emergency?

If you already have extra funds for the $2-3K emergency and you expect your future income to be relatively stable (barring catastrophe), then the Roth IRA is a pretty good option, as you can withdraw the principal without penalty.

[arebelspy]

I love this new forum, it encourages me to look things up and double check things I thought I knew.

Arebelspy is right, http://en.wikipedia.org/wiki/Roth_IRA  Contributions can be withdrawn at anytime.  So $5,000 per year you max out is available to you at any time if a Roth works for your particular situation as an efund.

Glad to help.  :)

And yeah, the sharing and contributing of knowledge is amazing!

I'd still recommend against using a Roth as an "emergency fund" (unless emergencies basically never happen to you, because your threshold of calling something an emergency is so high, it's more like a "the world is ending" fund), but you can access contributions without any tax penalty at all, even <5 years in.