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Should You Use a Roth IRA as an Emergency Fund?

by Shawanda Greene

Saving an emergency fund and investing for retirement are both important.

But squirreling away three to twelve months of living expenses may delay retirement investing for years. Fortunately, there’s a way to do both without doubling your income: Use your Roth IRA as an emergency fund.

Unlike the traditional IRA, with a Roth IRA, you can withdraw contributions–NOT earnings–any time before age 59 ½, tax and penalty-free.

Using a long-term investment vehicle as a short-term savings account is a bit controversial within the financial community.

I contacted Bill DuBose, CFP, to get his take on the matter. Here’s what he said,

I, personally, don’t think a Roth IRA is a good vehicle for an emergency account as it will generally be subject to market exposure. Yes, you can invest money inside a Roth in a money market account, but it is designed to be a long-term, retirement account and should be used that way.

gold piggy bank in nestBut current tax law limits annual Roth IRA contributions to $5,000, $6,000 for those who are at least 50 years old. If you fail to save money in a Roth IRA for a tax year, you can’t make up the shortfall in later years.

With your Roth IRA serving the dual function of a retirement and a savings account, you get the best of both worlds.

You don’t want the money you’ve earmarked for emergency expenses gobbled up by market losses when you need it, so leave it in cash or a cash equivalent fund within your IRA.

Depending on the financial institution, accessing your Roth IRA funds may be a fairly easy process. For instance, with Charles Schwab, you can complete the entire transaction online in minutes. Simply transfer funds from your Roth IRA to your brokerage account and then to your checking account.

If you’re prone to raiding your cash reserves for minor financial hiccups, stick with a traditional savings or money market account. You don’t want to develop the habit of cashing out your IRA for reasons other than a financial crisis or, you know, retirement.

To learn more about IRAs, check out IRS Publication 590.

Would you consider putting your emergency fund in a Roth IRA?


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{ 25 comments… read them below or add one }

Daisy @ Add Vodka August 17, 2012 at 10:37 AM

Hmm… I can never get the American investment vehicles straight. is the Roth IRA like the retirement savings or like tax-free savings account?
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Shawanda Greene August 17, 2012 at 11:45 AM

A tax-free savings account? I doubt such a thing exists in the United States. The Roth IRA is a retirement account. You make contributions with after-tax, earned income. Generally, at the age of 59 1/2, you can withdraw funds (contributions and earnings) from a Roth IRA tax and penalty-free. With the traditional IRA, you put money in with pre-tax dollars, and you pay the tax upon withdrawal.
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Dominique Brown August 17, 2012 at 7:27 PM

You have to wait 5 years to pull contributions out of the Roth or you get penalized. I think the Roth IRA for an emergency fund is only good if you have excessive amounts of cash lying around. If you don’t have say 5+ years of emergency funds lying around you are better off dumping your emergency fund in a savings account, because it’s liquid. You can get to it fast an you don’t get hit with a penalty for withdrawing before the 5 year mark in the roth. You see I didn’t even talk about market losses yet.. too risky in my book :-) . Great article usual!

sidenote: Do you watch Love and hip hop ATL? That’s the most rachet show I can find right after honey boo boo
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Shawanda Greene August 19, 2012 at 1:47 PM

You can withdraw contributions from a Roth IRA, but not necessarily the earnings, at any time. However, you gotta be careful when withdrawing funds from a rollover IRA or a conversion.

As for Love and Hip Hop Atlanta . . . now you know I watch it. I just heard about Honey Boo Boo (that thang). I don’t even know where to start. In terms of ratchedness, I’ll give Love and Hip Hop first runner up to Bad Girls Club.

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Dominique Brown August 20, 2012 at 3:54 PM

Ahh.. you’re right about the contributions

“Income tax and early-distribution penalty are never applied to distributed assets for which no deduction was allowed when the assets were contributed to the IRA.”

LOL at the ratchet ranking…
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Lance @ Money Life and More August 17, 2012 at 8:30 PM

I definitely wouldn’t do it. If you want a cash emergency fund why on earth would you waste your Roth Dollars on it. Put your emergency fund in cash and if you have money left over then invest in a Roth.
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Shawanda Greene August 22, 2012 at 8:13 PM

This method would mostly benefit individuals who don’t have the excess funds to stash money in a savings account and a Roth IRA. For some people, it can take years to accumulate a hefty emergency fund. During that time, they’re missing out on the opportunity to funnel money into a Roth.
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Joseph August 19, 2012 at 10:55 PM

It’s definitely an interesting idea, I probably wouldn’t do it unless the IRA was only a backup emergency fund though. Take advantage of the tax benefits, and rest easy knowing that in a real pinch you can access the money, but I’d feel more comfortable with at least one other source of emergency funds available to draw on before I’m forced to hit the IRA. As Bill said in the post, they are designed to be long term retirement accounts and are best used as such.

I’d also be a little bit nervous about the precedent that using my ROTH IRA as an emergency fund could set. You know, I’ve already spent my IRA, why not spend just a little more out of any other money that has been put aside for retirement.

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Shawanda Greene August 22, 2012 at 8:21 PM

I can understand the hesitation. Undisciplined spenders should go with a traditional savings account. However, I think there are some people who’ll reconsider what constitutes an emergency if they had to dip into their retirement funds.
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Kathleen @ Frugal Portland August 19, 2012 at 11:48 PM

I wouldn’t do it, unless it was a real emergency. Although, this is merely hypothetical, as my Roth IRA has a whopping $400 in it. So, actually, I’d tap that. If necessary.
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Shawanda Greene August 22, 2012 at 8:24 PM

I’m not advocating you loosen the standards for what’s defined as an emergency. Regardless of the vehicle you choose to house your emergency fund, you should only use those funds for actual emergencies.
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MyMoneyDesign August 21, 2012 at 12:48 PM

Not bad! In a pinch, you can use your Roth as another bucket to dip into during emergencies ONLY AFTER THE MONEY HAS BEEN IN FOR FIVE YEARS (very important note!) I used to think this was okay, but over the past year I’ve changed my opinion to the alternative one I just posted this Monday. Dipping into your Roth will deplete your retirement savings which is not something you want to do. Even though I wouldn’t call in an emergency fund, it is still an option for the most extreme of situations.
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Shawanda Greene August 22, 2012 at 8:37 PM

You can withdraw contributions to a Roth IRA tax and penalty-free at anytime. There’s conflicting information on the internet, so I dug up an IRA fact sheet from Vanguard, a resource I trust.
https://personal.vanguard.com/us/whatweoffer/ira/factsheet
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TeacHer August 21, 2012 at 8:25 PM

The 5-year rule that people keep referencing only applies to using contributions AND earnings towards an acceptable, non-retirment purchase like a home. So, for example, if I have $5,ooo in contributions in my Roth and $5,000 in earnings and it’s been open for at least 5 years, I can withdraw the full $10,000 for my downpayment if I want to. If it’s been less than 5 years, I can’t.

But the initial $5,000 in contributions? That’s mine to access anytime I want.

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Shawanda Greene August 22, 2012 at 8:41 PM

Thanks for the clarification. Although this post is short, it took me a while to get it done. I’ve heard for years that you can withdraw your Roth IRA contributions tax and penalty-free before you reach 59 1/2 years old, period. While researching this topic, I discovered there was a lot of confusion regarding the consequences of early Roth IRA withdrawals, which is why I contacted a CFP.
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Ornella @ Moneylicious August 23, 2012 at 11:49 AM

Money isn’t always fungible. So, it’s important you don’t mix retirement funds with emergency funds. It’s best you keep them separate.
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Shawanda Greene August 23, 2012 at 1:57 PM

If you can easily access your funds, have little to no risk of the money losing value, and you’re a responsible saver, I don’t see the harm in using the Roth IRA as an emergency fund.
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gold price August 26, 2012 at 7:20 PM

Using a Roth IRA as an emergency fund is attractive because, while the money is in the account, it has the potential to work harder on your behalf. (That changes, of course, if the investments in your Roth IRA lose value.) You don’t have to worry about penalties and taxes as long as you avoid dipping into your earnings. It’s considered something of a win-win: When you let the money grow, and keep making contributions, you help your retirement , but when you need the money now, you can withdraw your contributions.
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STEVEN J. FROMM, ATTORNEY, LL.M. (TAXATION) March 8, 2013 at 8:32 AM

This is a very dangerous idea. Most of us are undisciplined and to think about retirement money as anything but is just a bad idea. The power of compounding and front loading in your earlier years can generate a large sum of retirement money if invested in a diversified portfolio. Investing in money market accounts or other safe investments to avail oneself of emergency cash will not get you there. It is unwise to think social security retirement benefits will be enough and when you get older there is not enough time to get a large enough principal. This is just a bad idea from my perspective. But this is just a dumb tax attorney’s point of view.
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Bob Gold April 18, 2013 at 8:17 PM

I would only do this if I had no other options. It’s always better to save for an emergency in a liquid easy to access account. If, however, I just didn’t have any other money available and it truly was an emergency, then I’m glad to know about this option. Thanks for sharing.
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