I have had and loved my Roth IRA over the last few years. I mean, it really is a great deal the government is offering us and I always wonder why more people aren’t taking advantage of it. First you put in after-tax dollars NOW and withdraw it when you retire TAX-FREE. There are some people who might still benefit from using a Traditional IRA (depending on their current and expected tax bracket) but I think the Roth IRA is a good idea for the majority.
As if the tax-free withdrawal wasn’t enough, the ROTH is more generous when compared to the Traditional IRA. One of my favorite things about it is that you can withdraw all of your contributions tax and penalty free. A few years ago, (I don’t remember why) I had some kind of emergency come up that I needed the money so I just withdrew the amount I had contributed to my Roth that year. I didn’t have any tax consequences or penalties to be paid.
Have you ever thought of your Roth as an Emergency Fund?
It turns out that quite a few people are using their ROTH as an Emergency fund because of this feature. The benefit to gain would be that the money could grow tax-free, but wouldn’t cost you anything to pull it out when the time came.
The downside I see is that if you are invested in stocks and mutual funds, then the value could fluctuate and you would hate to have to pull your funds out when prices are low (remember buy low, sell high?). But one commenter in the Wisebread forums brings up a good point…
“Well, your Roth doesn’t have to fluctuate very much if you invest it in a money market fund so I think it could work out just fine if you designate a small portion to be your emergency fund. For the last year I put my new Roth IRA contributions in a money market fund so in case I need the money I could use it.”
So by having the funds in a money market within a Roth IRA you could be avoiding the taxes on interest each year while avoiding market fluctuations.
Another commenter mentioned another reason to use a Roth…
“Retirement accounts are somewhat protected in cases of lawsuits, bankruptcy, etc. If you suffer a financial catastrophe, it might be really nice to have (some cash) to start over with.”
My thoughts about the Roth Emergency Fund
While I can see the benefit of using it, I think I would prefer to tier my emergency fund a bit. Maybe have $3-$5K in an ING Account, and then have the remainder of the funds in a Roth that you could access the funds in an emergency – but hopefully would never have to. Technically you could be missing out by paying taxes on the interest earned from the $3-$5K – but it would be minimal and it would probably make your life easier.
The other thing to consider is that this just blurs the line between Retirement savings and Emergency savings. As these lines become blurred there may be a tendency to “take tomorrow’s bread today” so to speak.
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Great topic! I’ve written about this in a couple articles myself. I am using my Roth IRA as a portion of my Emergency Fund at this time. I call it “multi-tasking” my money.
Ideally, I want to have a funded Roth AND a 6-12 month Emergency Fund and eventually I will. But in the meantime, I don’t want to miss out on 2008 and 2009 Roth Contributions – which could have 40 year implications.
Now, I view this as a short term process. I suppose my contributions will technically always be available in an Emergency, but I want to move away from branding it an Emer Fund because I don’t want to maintain that mental linkage forever. But in the short term, allowing my money to serve a dual purpose seems like a good plan.
Thanks for sharing this… I had not read about this concept before talking with my planner and taking this step myself.
Thanks,
Dave
Very interesting idea, but I worry for myself of not having the discipline to really seperate Emergency from Retirement. For me compartmentalization makes good sense.
i think this “access” to funds in a Roth is a “nice to have” but one should not plan their Emergency Fund in this way. however, it does seem to help when you have a limited amount of funds to work with. I agree the ideal is to have the 3-6month E-Fund in a liquid savings account APART from your Roth. one thing you do not realize is the LOST gains you experience when you remove those contributions from the Roth. if you are young, you are potentially losing compounded 7-10% annualized gains if you have a moderately aggressive asset allocation which means your $5000 you just removed to deal with an “emergency” really costed you $20k-50k in TAX-FREE money in retirement. Thus, if one is going to pull out Roth money, make sure it is a REAL emergency and not just a “i need to have that new car” impulse buy.
“Emergency Fund” is one of the most important funds that you need to set up from your savings,..with job security already being a thing of past it always helps to have the fund to take care of your needs for 6-8 months.
Sounds pretty interesting, but I have some serious questions.
1) What money can you withdrawal penelty free? Is it any money you put in during that calendar year? Or any money you put in within the past 12 months?
Obviously if it’s by the calendar year, and you have an emergency in January, then you have a problem.
2) After 12 months, or after the calendar year, depending on question 1, your emergency fund, BECOMES your retirement savings, becuase you can no longer tap into it tax free. So whatever your emergency fund needs to be, minus the annual amount you put into your roth, needs to be stored away somewhere else.
Other than that, I think it’s a pretty good idea.
To Pochax, I think you could look at it in reverse. Where you would put $5,000 aside for emergency fund, you could put it into the roth and if you don’t have an emergency then great, you just made the compounded interest!
@Patrick:
1) you can withdraw ALL contributions (but not gains)..not just in the last tax year. If you have contributed $50k over 15 years and the Roth is now worth $100k (= $50k gains), you can withdaw up to $50k tax- and penalty-free. You will have to be careful and fill out all the correct forms during tax filing.
the problem with looking into it reverse:
it depends on what your definition of emergency is. Many people use emergency funds as a basket to dip into for the occasional overspending from their written budget. routinely doing this with a Roth can have major repercussions on future gains. i am not saying NEVER to use the Roth as an emergency fund, just to limit it to TRUE emergencies (catastrophic unexpected events) and still try to set up a more liquid emergency fund in a savings account.
It is a terrible idea to withdraw contributions from your Roth IRA. Unless you are in dire need, you are hurting yourself in the long run because that money won’t continue to grow for your retirement. Do NOT think of your Roth as an emergency fund!
You can withdrawal it all ??
Well what the heck, why don’t we make all our savings accounts a Roth? That sounds pretty swell, you still get all the investment options, and tax free withdrawals anytime you want.
@Patrick
just for the sake of clarification, it is just your contributions. I think you caught that Pochax said this, but I just wanted to make sure it is still clear…
I am planning on retiring next year, and I want to do a roll over,,I have not paid any taxes on my money, but I want to roll it over instead of paying a big tax on it all at once, then I want to with draw about 2,000 a month to help with the morgage,,do I pay the taxes each month when I with draw or at the end of the year? Do I have to pay a fee to with draw each month? With all that the last year has showed us with investments and banks ,,I am a little worry about my money.
Bob ( fellow Christian )