Author Topic: Roth IRA as emergency fund  (Read 5323 times)

AHLEditor

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Roth IRA as emergency fund
« on: February 08, 2015, 12:30:11 PM »
Since I noticed Roth IRA topics popping up here I figured I'd use this moment to raise an issue I am considering.

To date, I have taken the approach of keeping my emergency fund (typically in the 25k range + buffer in the main checking account) in a savings account accruing slightly below 1% annually.  It barely grows, but it's piece of mind being there compared to not having any pillow at all, or having my pillow tied up in hard-to-get or penalty-based assets.

However, I keep remembering every month I see the paltry interest payment that my checking account barely grows.  Since Roth IRA's can grow at higher rates, and I can withdraw principle penalty and tax free, I am strongly considering a strategy where, by moving over at max limits each year, my savings account is closer to 5-10k and then use Roth contributions as part of the 6-12 month emergency fund calculation.  This way, if things go as I would like and I never have to really touch it, it becomes another valued retirement vehicle.

So, would anyone like to poke holes in this approach? :)

nanu

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Re: Roth IRA as emergency fund
« Reply #1 on: February 08, 2015, 12:59:54 PM »
*posting just to follow this thread* (I was thinking about the same thing, and wondered about this)

Kernel Fielding

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Re: Roth IRA as emergency fund
« Reply #2 on: February 08, 2015, 01:58:07 PM »
You can withdraw without penalty or taxes if you are over 59 1/2 years old and have had the Roth IRA for at least 5 years.

If you don't meet either criterion, it may be possible to withdraw your contributions only penalty & tax-free (although you may have to prove which is contributions vs. earnings), but you won't be able to withdraw the earnings without penalty and taxes.

If you're under 59 1/2 years old, I'd recommend investing in index funds instead, which would much more flexible than a Roth IRA for purposes such as an emergency fund. You may have access to many or all of the same funds as in a Roth IRA, so it's possible your money can grow much faster than an interest-bearing savings account. You will have to pay taxes on your earnings on withdrawal, of course - but at least there won't be any early-withdrawal penalties (10%, ouch).

This link lays out the rules for Roth IRAs pretty well:

http://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/roth_ira/withdrawal_rules

GGNoob

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Re: Roth IRA as emergency fund
« Reply #3 on: February 08, 2015, 02:07:12 PM »
First off, you can invest your emergency fund so other than the fact that you'd have to pay taxes, it could grow as much as a Roth IRA could. You don't have to keep it in a savings account. A Roth IRA could also be in a savings account...so a Roth IRA won't always grow at higher rates.

Usually the only reason to use a Roth IRA for an emergency fund is if you can only contribute to an emergency fund or Roth IRA, but not both. If that's the case, then you may as well contribute to the Roth IRA. That way you don't let another year pass without making your Roth IRA contributions.

Gin1984

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Re: Roth IRA as emergency fund
« Reply #4 on: February 08, 2015, 02:24:53 PM »
I agree with Logan.  I put my cash EF into my Roth and when it gets high enough I move it from cash to mutual funds.  If I am lucky and don't need the money my Roth grows, if I need the money, well then the cash is there.

icek05

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Re: Roth IRA as emergency fund
« Reply #5 on: February 08, 2015, 03:07:35 PM »
I have no problem with the idea of a Roth as an emergency fund.  The obvious cautionary advice is to at least start off with a much more conservative asset allocation instead of going full into stocks.  Typically, an economic downturn can lead to job loss as well as a stock market crash, so you certainly don't want your emergency fund to drop 50% right at the moment you have to start taking withdrawals.  Also, since there is a penalty for withdrawals within 5 years you have to watch out for that also.
 
As the Roth grows you gain a bit more flexibility in the asset allocation.  As noted, it is incorrect to say that Roth IRA's grow at a higher rate because it is solely dependent on what assets you put in the Roth, if you have cash in there it will obviously grow less than stocks. 

77rider

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Re: Roth IRA as emergency fund
« Reply #6 on: February 08, 2015, 03:29:30 PM »
In the very back of my mind I do consider my Roth IRA contributions my 3rd or 4th line backup, uber emergency fund. I would dip into it if the poop really hit the fan before say, racking up high interest credit card debt. Fortunately this hasn't been an issue for me. Fortunately.

My Roth is invested exactly like my other retirement funds. At my age, a decent chunk is in relatively safe bond indexes. This raises the point that maybe that chunk should be more heavily into bonds and the 401k should be more aggressive. I like that idea.

I also keep a very liquid emergency fund.

RyeWhiskey

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Re: Roth IRA as emergency fund
« Reply #7 on: February 08, 2015, 05:57:00 PM »
All things equal, it is wiser to keep one's emergency fund outside of a Roth IRA because once money is withdrawn from the Roth (such as in the case of a hypothetical emergency) it cannot be returned after a short period. So one runs the risk of losing precious tax shelter space by considering one's EF as one's Roth.

This said, if the choice is taxable investing vs. Roth, the same logic applies: if you don't fund your Roth every year, you lose the opportunity.

Gin1984

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Re: Roth IRA as emergency fund
« Reply #8 on: February 08, 2015, 06:31:09 PM »
All things equal, it is wiser to keep one's emergency fund outside of a Roth IRA because once money is withdrawn from the Roth (such as in the case of a hypothetical emergency) it cannot be returned after a short period. So one runs the risk of losing precious tax shelter space by considering one's EF as one's Roth.

This said, if the choice is taxable investing vs. Roth, the same logic applies: if you don't fund your Roth every year, you lose the opportunity.
Except if my option is to either have an EF or fund my Roth, by keeping my EF in my Roth I am able to not lose the tax shelter space, if I don't have an emergency.  And even if I do, the interest is now free to move into my index funds and continue to grow.  I agree that if you have the funds to max out all your tax advantage accounts plus an EF having the EF outside the Roth makes sense but for those who can't, why not use the Roth?

Emilyngh

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Re: Roth IRA as emergency fund
« Reply #9 on: February 09, 2015, 08:26:14 AM »


If you're under 59 1/2 years old, I'd recommend investing in index funds instead, which would much more flexible than a Roth IRA for purposes such as an emergency fund. You may have access to many or all of the same funds as in a Roth IRA, so it's possible your money can grow much faster than an interest-bearing savings account. You will have to pay taxes on your earnings on withdrawal, of course - but at least there won't be any early-withdrawal penalties (10%, ouch).


You can have your money in index funds under a Roth umbrella, so it isn't one or the other and as long as you only withdraw contributions there are no penalties. 

But, back to the OP's question: we have our emergency funds in Roth IRAs (index ETFs in Roth accounts), and in my humble opinion it's a great place to stash them.    It gives me the peace of mind that we can get to money if we need it without additional penalties or taxes, but so far, we haven't had to pull from it and it continues to grow with all gains being tax free.   I recommend deciding how much you need for an emergency fund, putting only this amount in Roth, and then focusing on maxing tax deferred accounts (what we're currently doing).   
« Last Edit: February 09, 2015, 08:27:58 AM by Emilyngh »

Eric

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Re: Roth IRA as emergency fund
« Reply #10 on: February 09, 2015, 10:13:28 AM »
I have no problem with the idea of a Roth as an emergency fund.  The obvious cautionary advice is to at least start off with a much more conservative asset allocation instead of going full into stocks.  Typically, an economic downturn can lead to job loss as well as a stock market crash, so you certainly don't want your emergency fund to drop 50% right at the moment you have to start taking withdrawals.  Also, since there is a penalty for withdrawals within 5 years you have to watch out for that also.
 

This is a good point.  Since you'll be invested within the Roth, you're at a greater risk of having to dip into your EF when stocks are down.  However, an alternative to a conservative asset allocation is to just simply have access to more money.  I don't mean that to sound flippant, but the more money you have, the more this strategy makes sense.  If the Roth is your only source of emergency funds, it's more risky than if it's say a backup source as you keep a little in savings plus some more in a regular brokerage account.

Revelry

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Re: Roth IRA as emergency fund
« Reply #11 on: February 09, 2015, 10:50:26 AM »
But, back to the OP's question: we have our emergency funds in Roth IRAs (index ETFs in Roth accounts), and in my humble opinion it's a great place to stash them.    It gives me the peace of mind that we can get to money if we need it without additional penalties or taxes, but so far, we haven't had to pull from it and it continues to grow with all gains being tax free.   I recommend deciding how much you need for an emergency fund, putting only this amount in Roth, and then focusing on maxing tax deferred accounts (what we're currently doing).

That's how we've decided to do it as well.  We have 5k in cash/online savings for immediate use if necessary, but I just couldn't justify building that EF further (and earning 0.7%) instead of paying extra to the mortgage.  With the Roth IRA and a Vanguard Lifestrategy fund, I can stash away a decent chunk for a third-tier emergency and not have to worry about learning tax laws for capital gains and such.  If I can put 10k in there for '14 and '15 contributions and the market takes a giant 20% drop next year, I'll still have plenty of contributions to tap if necessary.
I consider my job very secure so that plays into my consideration.  And once the Roth is funded up to a level where I'm satisfied I'll switch to a traditional IRA for true retirement savings outside my TSP.

Ynari

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Re: Roth IRA as emergency fund
« Reply #12 on: February 09, 2015, 11:53:07 AM »
In a way, I've done this.  I just graduated, and had about 6 months of expenses in my bank account at that point in time. (That's the real "emergency" fund.)  If I can't find a job in 6 months, I have about another 6 months worth of expenses in my Roth IRA.  So, it's my backup emergency fund.

But I really think that 6 months, even in a poor situation, is enough for me to find SOME job. I wouldn't have put the money in there if I had thought there was a high likelihood of needing it soon.

Personally, I'm fine with keeping 6 months of expenses liquid and the rest of my money invested.

rmendpara

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Re: Roth IRA as emergency fund
« Reply #13 on: February 09, 2015, 12:38:42 PM »
Personally, I wouldn't bother with that, but it's a valid argument why that makes sense, especially depending upon your needs for emergency funds (amount) as well as your overall comfort for withdrawing retirement funds.

Seems like you're going from one end (all cash) to another (all invested inside a Roth). Investing part or all of that 25k in some balanced funds will likely outperform your 1% (or 2-3% if rates normalize in the future) and be far more liquid for withdrawal or whatever needs if you just leave it in a taxable account.So why not just keep the same mutual funds in a taxable account? The real difference will be taxation of earnings (dividends and/or interest earnings), as well as the benefit of a tax loss if you have to withdraw those funds after they drop in value. If you do that in a Roth, you just have to eat that loss.

RyeWhiskey

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Re: Roth IRA as emergency fund
« Reply #14 on: February 09, 2015, 06:57:01 PM »
All things equal, it is wiser to keep one's emergency fund outside of a Roth IRA because once money is withdrawn from the Roth (such as in the case of a hypothetical emergency) it cannot be returned after a short period. So one runs the risk of losing precious tax shelter space by considering one's EF as one's Roth.

This said, if the choice is taxable investing vs. Roth, the same logic applies: if you don't fund your Roth every year, you lose the opportunity.
Except if my option is to either have an EF or fund my Roth, by keeping my EF in my Roth I am able to not lose the tax shelter space, if I don't have an emergency.  And even if I do, the interest is now free to move into my index funds and continue to grow.  I agree that if you have the funds to max out all your tax advantage accounts plus an EF having the EF outside the Roth makes sense but for those who can't, why not use the Roth?

Yes, in your situation it is wisest to fund the Roth and keep your EF there until you can make a taxable account. There is no reason to unnecessarily give up tax shelter space.

Bbqmustache

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Re: Roth IRA as emergency fund
« Reply #15 on: February 10, 2015, 04:29:57 AM »
Please learn to look at your Roth with "old and grey" glasses on.  Fund the heck out of it, but let the principal work for you long term and leave it the hell alone!

If you are in the US, see what credit unions in your area are offering.  Some still have ok rates on liquid money.

LordSquidworth

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Re: Roth IRA as emergency fund
« Reply #16 on: February 10, 2015, 09:47:52 AM »
I wouldn't. Roth IRA is too powerful an account, especially if you're young. It's also a use it or lose it account. Take the money out, you get to put less in.

Stick the Emergency Fund in short term bond fund. Won't be glorious, but it'll be better than cash or savings.

GGNoob

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Re: Roth IRA as emergency fund
« Reply #17 on: February 10, 2015, 10:34:11 AM »
I wouldn't. Roth IRA is too powerful an account, especially if you're young. It's also a use it or lose it account. Take the money out, you get to put less in.

Stick the Emergency Fund in short term bond fund. Won't be glorious, but it'll be better than cash or savings.

You're right, its a use it or lose it account. If the OP cannot afford to contribute to emergency savings AND a Roth IRA, then it makes sense to use the Roth IRA as an emergency fund. Then if the money is never needed for an emergency, it can remain in the Roth for retirement.