Using Roth IRA as Emergency Fund?

[amyschiff]

I was just wondering if anyone else is using a Roth IRA as part of their emergency fund? Since you can withdraw your contributions at any time tax-free, it can serve as some extra liquid cash in the case of an emergency.

My fiance and I recently started up our Roths, and also have a little leftover in a savings. I know that you ideally wouldn't want to withdraw from your retirement account, but I like the idea of having my money doing double-duty as savings and an investment.

[starshard0]

How does the withdrawal process work? Are there any fees or penalties at all?

[amyschiff]

Nope. No fees or penalties for withdrawing your contributions (which you can max out at $5000 in 2009). It's when you try to withdraw your earnings that you can incur fees and penalties. Since the money you put into your Roth has already been taxed once (IE you paid income taxes), you can withdraw the money you contribute tax free.

I found a good article with a lot of resources: http://www.fivecentnickel.com/2006/0...contributions/

[starshard0]

Doesn't sound too bad, does anyone else have an opinion about it?

[KevinW]

This is one of the advantages of Roths over traditional IRAs.

The downside is that you have only a brief period to put those contributions back in (don't recall the exact number). After that time runs out, the withdrawal becomes permanent and you are only allowed to deposit money back in up to the (currently) $5k/year limit. If that happens you've permanently lost the ability to tax-shelter those dollars.

But in a true emergency, being able to get at that money without penalty is probably worth that tradeoff.

[starshard0]

I knew there had to be some kind of downside. While it's not a total bummer, I'd still think it better to have some money outside of the IRA to use before resorting to IRA funds.

[Kathryn]

I think one of the downsides of looking at your Roth as part of your emergency fund is the fact that its value fluctuates on a cycle that is not necessarily timed to the cycle of your need to tap into it. Indeed, it's probably quite the opposite--people on average probably more likely to need to tap an emergency fund during hard economics times when the value of your investments is low, and be able to re-fund it during good economic times when the cost of buying investment vehicles is high.

In other words, a good set-up for buying high and being forced to sell low, and then buying high again when things turn around. This negates or even inverts part of the advantage of a Roth vs. sticking your money in a savings account--greater return on your investment.

[starshard0]

So it's possible, but there are catches and downsides. I think I'll stick with a traditional high-yield savings account.

[Xin Lu]

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. There is no penalty to withdrawing your contributions like the OP said, but I would only use it in a true emergency

[amyschiff]

Originally Posted by Xin Lu

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.

Ahh this is an interesting strategy which I will be looking into. I'm definitely not planning on taking any out in the foreseeable future, but I guess the thing about emergencies is you don't really ever foresee them. We will still have some in a plain old savings account, but it's nice to have a 2nd line of defense before resorting to credit cards.