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.
But 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?