Bank Deal: Earn 1.00% APY on an FDIC-insured savings account at Barclays Bank.
Building an emergency fund is one of the critical first steps to personal financial success. With that in mind, a reader named LG recently wrote in with a question about using a Roth IRA as an emergency fund:
I know you’ve written a lot about emergency funds, but my question is can a Roth IRA serve as an emergency fund?
At first blush, the answer seems obvious. Roth IRAs are designed for retirement investing, not for use as a short-term savings vehicle. Thus, nobody in their right mind would use a Roth as an emergency fund. Or would they?
Making Roth IRA withdrawals
Did you know that you can withdraw your Roth IRA contributions without paying any taxes or penalties? This rule applies only to your contributions, but it provides a significant degree of flexibility when it comes to managing your Roth IRA.
At the same time, I would caution against pulling money out of a Roth IRA unless absolutely necessary, as your future contributions will still be subject to the normal contribution limits. In other words, you won’t be able to simply put the money back into your account.
Roth IRA as emergency fund?
With the foregoing information as a backdrop, let’s return to the original question… Can a Roth IRA serve as an emergency fund? Yes, with some limitations, it can.
More importantly, should you rely on your Roth IRA as an emergency fund? In my opinion, the answer is no, except under very specific circumstances.
Beyond the inability to put your money back into your Roth IRA after you recover from whatever emergency happens to crop up, you also have to consider the issue of liquidity and accessibility.
If your Roth funds are invested in a “normal” fashion, then you likely have at least some of the money in stocks. If you rely on your Roth as an emergency fund, you might be forced to sell investments when the market is down.
As for accessibility, even though you’re allowed to withdraw your contributions whenever you want, it could take a week or so to receive funds from your IRA custodian. Thus, you shouldn’t rely on a Roth IRA to cover you in circumstances that require immediate access to your money.
When you should consider it
I noted above that relying on your Roth IRA as an emergency fund is a bad idea except under very specific circumstances. The circumstances that I’m talking about are when you have a healthy emergency fund in place, but not enough excess to contribute to a Roth IRA.
In this case, you might want to consider using a portion of your emergency money to fund a Roth IRA, secure in the knowledge that you can always pull the money back out if an emergency crops up.
There are two important caveats here. First, be sure to keep enough cash in a local account to cover any short-term, immediate needs that might arise. That way you won’t find yourself in a pinch as you wait for the check from your IRA custodian.
Second, don’t invest this money in anything that is subject to market fluctuations. Instead, keep it in a money market fund, or something similar. Once your emergency fund recovers (more below) you’ll be free to invest more aggressively.
Once you make the contribution to your Roth IRA, it’s time to buckle down and rebuild your emergency fund. If something goes wrong and you need to pull the money back out, there was no harm done. After all, you wouldn’t have contributed to the Roth in the first place, so you don’t really lose anything by withdrawing your contributions.
On the other hand, if all goes well and you get your emergency fund rebuilt before you need it, you’ll be a step ahead. You’ll now have a fully-funded emergency fund plus money in a Roth IRA. At this point, you’ll be free to invest the Roth funds more aggressively.
Obviously, you can repeat this process many times over, and don’t forget that it works the rules are essentially the same for a spousal IRA. Thus, depending on your circumstances, both you and your spouse can take advantage of this strategy.
- How to Become a Millionaire
- How to Get Out of Debt
- The Best Dollars I've Ever Spent
- How Our Estate Plan is Structured
- How We Paid Our Mortgage In Less than 10 Years
- Money Making Ideas
- How to Manage Your Asset Allocation with Multiple Accounts
- Consumption Smoothing - Save While the Saving's Good
- How to Save on Groceries
- How Much Life Insurance Do You Need?
- Eleven Great Books About Money
- Dave Ramsey is Bad at Math (692)
- Dish Network Customer Service SUCKS (534)
- $8,000 Homebuyer Tax Credit (429)
- Pay Off Mortgage Early or Invest? (424)
- How to Claim the First-Time Homebuyer Tax Credit (352)
- Termite Control: Sentricon vs. Termidor (325)
- How Much Should You Pay a Babysitter? (284)
- Ethanol Blended Gas = Lower Mileage? (272)
- Reduced Credit Limits? Share Your Experience (256)
- $15,000 Homebuyer Tax Credit (242)
- Buying Furniture off the Back of a Truck (227)
- Will Mac OS X Lion Kill Quicken 2007? (191)