Roth IRA as emergency fund

[jaine]

What are your thoughts on using a Roth IRA as an emergency fund?

If you google "roth ira emergency fund bankrate" you'll see the article I stumbled across today. It was quite a surprise to me that Roth IRA contributions aren't subject to the income tax and penalty if you need to withdraw them early. It's only the earnings that are subject to income tax and 10% penalty if you withdraw them too soon.

Very interesting.

[disneysteve]

I generally say no to this idea, but I'm admittedly biased because my Roth is my only tax-sheltered retirement account. Tapping that for anything other than retirement would be pretty stupid.

However, there are people who are fully funding 401k plans and/or still have generous pension plans. The Roth really isn't needed for retirement but is just being funded as an extra savings cushion. In that case, pulling some money out wouldn't be so terrible.

I just don't like the idea of thinking of a retirement account as anything other than a retirement account. Lots of people get into trouble taking 401k loans. I would prefer if all retirement accounts were untouchable until retirement.

[jpg7n16]

I think if you have an emergency and need to withdrawal say $10k... you're still only allowed to put back in $5k for the year. I think.

That'd be bad if you generally contribute the full $5k for the year because then you'd be set back 2 years, and could never catch the ROTH back up. Whereas in a MM account, you're always free to put in extra.

Plus the main purpose of having the EF in a money market account is that you don't want your EF subject to the fluctuations/risk of the market. You need it to be sure to be there. Usually ROTH funds are invested in stocks.

[disneysteve]

Plus the main purpose of having the EF in a money market account is that you don't want your EF subject to the fluctuations/risk of the market. You need it to be sure to be there. Usually ROTH funds are invested in stocks.

This is a good point. If you are planning to use your Roth as an EF, you'd want to keep in conservatively invested, most likely in a money market fund. Again, if this is money you will not need in retirement, I suppose that's okay, but I think there are better ways to go about it.

[MonkeyMama]

I like and utilize the ROTH emergency idea.

2 points though:

1 - My definition of "emergency" is quite narrow (catastrophic). Meaning, very slim odds I would ever use it. I also do not keep my entire emergency funds in ROTH. Just the more catastrophic portion.

2 - I have ample retirement savings in addition to my ROTH. I actually consider my ROTH to be a lot more than just retirement. Maybe college savings, etc. I couldn't justify putting 25% of my gross income to solely, retirement, right now. (& not saving for anything else??) But the character of the ROTH makes it a decent savings place for other things, if you feel retirement is well covered. Thus, knowing I can tap it for other things, I generally try to put in as much as I can. I am happy with considering 15%-20% as the retirement portion, right now. 5% college savings, etc.

Definitely - efund is only in cash. I've had it in CDs and MMMFs.

[bjl584]

No.

If you are in a financial position where you really don't need your Roth for retirement, then you don't need to use it as an EF. You most likely will have an EF in cash as a traditional bank account.

[jIM_Ohio]

If the Roth is the only funds you have, its the "last thing" you would ever want to touch... you wouldn't want to touch it and if you did the likelihood you would ever recover is slim to none.

and if the Roth is one if many funds you have (like cash savings, home equity, 401k etc...), it is still the last thing you would ever touch... you still would not want to touch it, but if you did, you could probably recover depending on "emergency".

An emergency should not be a high credit card bill, car repair, or even making a mortgage payment. An emergency might involve a hospital, long time period without work (because of disability) or death in family type catastrophic event.

[jaine]

The more I think about this idea the more I like it. I like the thought of keeping a small cash emergency fund on hand for minor bumps like car repairs and small medical bills - and using the Roth IRA if (and only if) there's a catastrophic emergency like extended job loss or huge medical bills.

I agree there are so many downsides (it's retirement savings, it's in stocks and I might have to sell when the market is bad, I can't make up the contribution amount later, etc) - that actually makes it seems like a good emergency fund to me because those things will motivate me to leave it alone.
Only a true catastrophic emergency would outweigh that desire to leave it alone.

With cash on the other hand ... historically, for me at least ... a cash emergency fund ends up morphing into some other purpose, like a down payment on a house ... something else that's not catastrophic.

[jaine]

PS. I agree I wouldn't want to use it if it was all of my retirement savings ... I think I'm safe on that front. I have about 80K saved for retirement so far and the Roth IRA is 1/4 of it. I am only 28 so I have a good head start... I have been diligent about contributing the maximum amount whenever possible since I started working.

[Thrif-t]

I believe I may have heard Suze Orman advocate this. It makes for a good shelter when it comes to kids and college and the whole FAFSA thing for financial aid.

[MonkeyMama]

I think the point that is kind of missed, is that the purpose of this strategy is to make it easier to max out your ROTHs, etc., when it otherwise might not make financial sense. It might not make sense for a young person starting out to max out their retirement if they have no cash savings. The whole point is to not giving up retirement contributions that you can never make up.

For me, that is what it is about. I can max out my ROTHs when it otherwise doesn't make much sense. I will never get back a chance to put away money for past years. (For us, period of temporary lower income. Which is when the ROTHs are the most advantageous, when you pile them with non-taxed or low-taxed income).

People will abuse ROTHs just as they do 401ks and credit cards and everything. Doesn't mean there are no savvy ways to use the system.

[FHA Loan]

What are your thoughts on using a Roth IRA as an emergency fund?

If you google "roth ira emergency fund bankrate" you'll see the article I stumbled across today. It was quite a surprise to me that Roth IRA contributions aren't subject to the income tax and penalty if you need to withdraw them early. It's only the earnings that are subject to income tax and 10% penalty if you withdraw them too soon.

Very interesting.

Not sure why this would be surprising since the money you put into your Roth is AFTER tax money. You've already paid taxes on it. It's only the money that the Roth IRA earns over time that should be taxed (and if applicable, penalized) when you withdraw.

[maat55]

Obviously, when you take money out of your roth it cannot be replaced. I would not consider my roth as an EF, but I would not rule it out as an last resort.