Emergency Fund Building

[kv968]

Let me throw this out for discussion:

The rough look at the "proper" way to begin investing is:
1) pay off real high interest accounts (ie. credit cards)
2) save enough in an emergency fund
3) begin investing

What I'm planning on doing however is to somewhat combine #2 & 3. I don't have a totally sufficient emergency fund (EF) set up as of yet, but I still plan on investing the max in a Roth IRA. The way I figure it is that since the opportunity to start participating in a Roth goes away each year (ie. you can only max out at $4,000/year if under 50 and can't go back to catch up for previous years lost) I'll max out my Roth for this year and consider that an interim "emergency fund" as I continue to save for the real EF. That way I don't miss out on the chance to open and max out an IRA while I'm building up my EF. I know you're not supposed to take money out of retirement accounts due to the defeating purpose it has on gains, but if used as a TRUE emergency fund, there should be no need (hopefully) to touch it. If I do need the money, well then I'll have to take it out (no penalties on your contributions). I'll miss out on the interest the money could have been making, but that's a risk I'll take. However, if an emergency doesn't arise before I can properly establish the REAL emergency fund then I'll be 2-3 years already invested in an IRA.

To give an example:
I have only $4000 this year to invest and I need say $6000 for an EF. I'm putting the $4000 in a Roth for this year as opposed to the EF. Next year I'll have $6000 to invest. Instead of putting the $6000 in an EF (and missing out on a year eligibilty of the IRA), I'll max out the Roth again and put $2000 in the EF. I'll repeat for the next two years and then I'll have a fully funded EF and an almost maxed-out 4 year Roth started. Notice I say "almost maxed-out" because the contribution limit for an IRA rises in 2008 but for argument's sake we'll keep it at an even $4000. I know that by that time there may be a little more money needed in an EF than the $6000 dollars I currently need but I'll catch up the small difference and in the meantime I have a fully funded Roth. Whereas if I put all of it into an ER as soon as I was able, I'd miss out on a full year of a maxed out Roth and a year with only a 50% funded Roth.

Hope that wasn't too confusing. I know it's not perfect and not for everybody but it is a slightly different way of looking at things and getting started. Comments and/or concerns are appreciated

[kunoichi]

I was in much of the same situation as you not too long ago. I was going to fund my IRA but ended up sending it to my ING savings account. As it turns out, I had to use the money and I was glad I had it "right there". Still I think in a situation like this where there is no penality on the contrabutions themselves, it is really up to how you want to handle the situation. I know many people who would cry foul, but if it works for you, then go with it.

[MonkeyMama]

I am about in the same boat. I want to grow the emergency fund, but at the same time I am not sure if it is the smartest to forego our entire ROTH contributions. For now I am just plain uncomfortable not having as much cash as we used to - we ran through it last year - well needed. I plan this year to put all our money in Cash, but I am getting an extremely large employer contribution - $13k or so, so this is how I justfiy it - still getting a big bump in retirement funds.

BUT what I do plan to do is set aside all I Can in savings and re-evaulate at the end of the year. IF we have a really good year and save a lot, and no big unforeseen financial outflows - we have until April 2008 to make our 2007 IRA contribution. At that point I would not be surprised if we decide to make a full IRA contribution, or nothing because looking back we had some financial emergency or a really bad year. You can use hindsight to make your decision. THat is the beauty of IRAs.

I believe a ROTH contribution you can withdraw penalty-free and tax-free. There may be a holding period to take it out penalty-free, been meaning to double check. But I think overall it is a good way to go. If you regret putting too much in a ROTH down the road, and have a cash emergency - it will be pretty accessible. Vs. 401ks and such with penalties and taxes. To me, I would not touch my retirement with a 10-foot pole, and there are other downfalls of premature withdrawals, BUT it makes me a little more comfortable foregoing the e-fund in the meantime and maxing out my retirement contributions. Knowing a safety net is there for a bad scenario. My chances of unemployment are about nil right now so affects my decision - there are a lot of individual factors to consider. I have 1 months pay saved in cash and feel that is more than sufficient as a bare minimum. I hope to get it to 3 months pay though before I max out retirement again.

[kristinecfp]

Originally Posted by MonkeyMama

I believe a ROTH contribution you can withdraw penalty-free and tax-free.

You're correct MonkeyMama - You can withdraw your contributions from a Roth IRA anytime without tax or penalty. This applies to contributions only - you can not take out the earnings on your contributions, or you will pay taxes & penalties. It also only applies to contributory Roth IRAs, not Roths that were converted from traditional IRAs.

For that reason, I generally recommend that clients (I'm a financial planner) contribute to both their emergency savings account and a Roth IRA (if they are eligible) at the same time.

I've found that most people have a hard time saving the recommended 3-6 months of living expenses for an emergency fund, so if they waited to start saving for retirement until they had funded their emergency fund, they'd never get started saving for retirement!

[Ima saver]

I think it is smart to max out your roth. I didn't get to even open one until in my 40's, and could only put in $2000 a year. Some years, I missed and I regret that.

[kv968]

Originally Posted by Ima saver

I think it is smart to max out your roth. I didn't get to even open one until in my 40's, and could only put in $2000 a year. Some years, I missed and I regret that.

That's why I'm planning on doing what I'm doing. I don't want the regret later on.

Originally Posted by kristinecpa

"...waiting to start saving for retirement until they had funded their emergency fund, they'd never get started saving for retirement."

And not that I fall into that category completely because I do have a decent amount in a 401k and a little cash on the side for some minor emergencies. I just want to get the IRA rolling since I'll be knocking on 40's door in a couple of years

[Broken Arrow]

Technically, I set two emergency fund goals: A baby one and a full one.

The baby one was accomplished as soon as possible so that I would have something to fall back on. At the time, I decided that 1k will do. Then I started attacking high interest debts. Eventually, I turned around back to building a full emergency fund. I actually have my ex to thank for that, because the way we were butting heads, I was nearly positive that we would have to go to court to settle our divorce. So, I had to make sure that I had enough to do so. Luckily, that didn't happen, so I was able to just turn that fund into my full emergency fund.

My basic financial goals are outlined in my signature.

[kv968]

Congrats on getting through your a good portion of your financial goals. Like you said, "baby steps". However I don't see any fund set up for retirement. Are you planning on that or is that already underway?

[Broken Arrow]

That part is already underway, and it isn't a finite goal that I am trying to hit so....

[kristinecfp]

Originally Posted by Broken Arrow

Technically, I set two emergency fund goals: A baby one and a full one.

This is a good strategy if you have high interest credit cards or other urgent financial plans that need to be addressed.

It doesn't make much sense to save up $10,000 in an emergency fund if you have credit card debt at 30% ~ this is just an example, not saying that anyone in this thread is in this situation!