Use Roth IRA as Emergency Fund

[brown3218]

I am using a 401k for my primary retirement savings. I'm currently taking full advantage of my companies match (100% match up to 7%). I currently make $50,000 a year and I am married. I only have a $1500 emergency savings fund, and I know I need to increase this to at least 3 months (about $12,500). I'm really not in the position to be making more 401k or Roth contributions until I build my emergency fund. I think it will take me years to get to $12500. Is it ok if I just move my $1500 to a Roth IRA and then continue to build up my emergency fund by making contributions to the Roth?

[Clever_Username]

Hi there,

There's an article about using Roth IRA as an emergency fund in the wiki.

By the way, you list about 3 months' salary as your desired emergency fund. Are you spending that much? The usual suggestions are based on some period of time's expenditures, not income.

[NYBoglehead]

I wouldn't plan on using the Roth for 100% of my emergency fund. I am not suggesting that you have a full 6 months in cash on hand, I would keep a decent amount of liquid savings in the event of an emergency, you don't want to have to tap the Roth immediately if you find yourself needing cash.

As the poster above noted, plan on setting aside a few months worth of expenses, not income. Right now it appears you are saving a decent percentage of your income, so your expenditures should be well below your income at this point. Another added benefit of the 401k is that you can give yourself a raise when you contribute to one. While you don't want to leave any company match on the table if you find yourself needing a little more money you can change your contribution rate to achieve a larger paycheck if you really need the money.

[Taylor Larimore]

Brown:

Welcome to the Bogleheads Forum!

Is it ok if I just move my $1500 to a Roth IRA and then continue to build up my emergency fund by making contributions to the Roth?

In my opinion, the answer is probably "yes."

You don't need to "overthink" this for cash you may never need, especially if you have other sources of cash (credit cards, credit union, checking accounts, bank loan, family, etc.)

Best wishes.
Taylor

[scubadiver]

I wouldn't plan on using the Roth for 100% of my emergency fund. I am not suggesting that you have a full 6 months in cash on hand, I would keep a decent amount of liquid savings in the event of an emergency, you don't want to have to tap the Roth immediately if you find yourself needing cash.

I agree with NYBoglehead regarding utilization of the Roth for 100% of the emergency fund. You need to maintain some liquidity so as to avoid tapping the Roth account because your washing machine just died.

We presently maintain about six months of expenses in a combination of CDs, money market accounts and savings accounts with our Roths serving as a "No kidding, we've got a problem" account. You don't need to keep a six month fund in cash savings like we do, but I would shoot for at least two or three months. Unanticipated expenses on the order of $1K or $2K are not that uncommon, particularly if you have a home or older car.

[bdpb]

You need to maintain some liquidity so as to avoid tapping the Roth account because your washing machine just died.

The OP does not lose any liquidity by holding his EF in a Roth account. He can tap his Roth account just as easily as a checking account.

[Taylor Larimore]

You need to maintain some liquidity so as to avoid tapping the Roth account because your washing machine just died.

The OP does not lose any liquidity by holding his EF in a Roth account. He can tap his Roth account just as easily as a checking account.

bdpb:
You're right about "liquidity". It is easy to withdraw contributions from his Roth IRA anytime, but he cannot put his withdrawal back into the Roth because he is limited to total contributions of $5,000/year ($6,000 if over age 50). This means that the OP will lose the tax-free accumulation of that part of his Roth forever. Nevertheless, he's no worse off than if he had put the money in a taxable account in the first place.

This article should be helpful:

Use Roth IRA as your backup emergency fund

Happy Holidays!
Taylor

[Default User BR]

You're right about "liquidity". It is easy to withdraw contributions from his Roth IRA anytime, but he cannot put his withdrawal back into the Roth because he is limited to total contributions of $5,000/year ($6,000 if over age 50).

He can within 60 days, as an indirect rollover. But only once every 12 months for that account.


Brian

[Epsilon Delta]

You need to maintain some liquidity so as to avoid tapping the Roth account because your washing machine just died.

The OP does not lose any liquidity by holding his EF in a Roth account. He can tap his Roth account just as easily as a checking account.

At the OPs income level he is probably eligible for $400 of savers credit a year. Any withdrawals from a Roth may jeopardize that credit for the next 3 years. This provides a significant incentive to maintain some liquidity in taxable accounts to avoid "churning" a Roth due to small emergencies.

[bdpb]

The OP has plenty of tax advantaged space. He's not anywhere near the max. He won't lose any tax advantage space that he can't get back whenever he has the savings to replenish his EF.

The OP already contributes $3500 to his 401k over and above his Roth contributions. A small emergency won't jeopardize his saver's credit.

[Epsilon Delta]

Following bdpb

The OP already contributes $3500 to his 401k over and above his Roth contributions. A small emergency won't jeopardize his saver's credit.

Three "small" $501 emergencies over 3 years do affect his eligibility for savers credit. And you need to consider his wife's contribution.

By the way maximizing the savers credit requires contributing at least $2000 per year to each spouses retirement accounts. He's already covered his own with the $3500 401k contribution so the next $2000 of savings (or as much as he can save if less) should go to his wife's IRA to get a 10% match from the savers credit.

[bdpb]

Following bdpb

The OP already contributes $3500 to his 401k over and above his Roth contributions. A small emergency won't jeopardize his saver's credit.

Three "small" $501 emergencies over 3 years do affect his eligibility for savers credit. And you need to consider his wife's contribution.

By the way maximizing the savers credit requires contributing at least $2000 per year to each spouses retirement accounts. He's already covered his own with the $3500 401k contribution so the next $2000 of savings (or as much as he can save if less) should go to his wife's IRA to get a 10% match from the savers credit.

He has no money to contribute to his wife's IRA to get her saver's credit unless he uses his EF.

The withdrawals only affect the current year's credit. He can't lose this year's credit if he waits until near 4/15/2013 to make her 2012 contribution.

Edit: He can actually make the $1500 contribution immediately since he will still be at $2000 with a $1500 withdrawal. Beyond the $1500 requires a little more thought, "Do I risk losing his future credits by capturing her credit?"

[scubadiver]

What I meant to suggest by liquidity is that the Roth not be the first account to be tapped, so have some liquidity to avoid Roth withdrawals.

When you take money out of a savings account you don't have to worry about whether it's principle or dividends. You also don't need to be concerned about whether it impacts eligibility for some tax credit or whether you have 30, 60 or 90 days to replace it without issue. And what happens if we have another 2007-2009 bear market where the OPs 4 month EF becomes a 2 month EF because it was invested in a 2040 target retirement fund? So now we have to decide how we take money which is primarily intended for and benefits from long-term tax free growth and invest it to avoid short term losses.

Is it possible to manage those issues? Absolutely. But the OP currently has a $1500 EF. I'm thinking the OP needs a EF management 101 set of guidelines and a lot of the discussion is focusing on issues that come up in the EF Management 201 course. I think his current needs (and hence priorities) should be pretty simple. First, save up 2 months of expenses. Put it in a savings account, keep it under a mattress or burry it in a jar in the backyard. Anything will do, just save up some money. Second, once you have some money set aside, start looking at which investment firms you would like to go with and consider opening a Roth. BTW, for many firms, $1500 is a minimum investment, if that. I'm sure others can point the OP to reputable firms that have a low minimum balance, but this is also something to consider. Once you have months 1 and 2 established, then you could consider saving months 3+ in a Roth account.

In the longer term, if the OP really wants to go 100% Roth for the EF, that's his choice, but I think he needs to educate himself on how to manage that and I would start with something simple just to get rolling. That's how I did it and it seems to have worked well for me. There's nothing wrong with going 100% Roth from the start, you just need to maintain good situational awareness and a clear understanding of when and what the money will be used for. For example, our EF also functions as a new car purchase / home improvement / vacation fund. The dollar amounts that we maintain in cash savings tend to vary between 5 and 9 months of expenses. Last summer I used it to fund a new deck and roof with skylight. Once the work was completed, I just wrote the contractor a check for $17K and was done with it. Could I have done that with money from a roth account as well? Sure, but there's probably a few more steps and considerations involved. Maybe I'm just lazy.

[bdpb]

Nobody suggested the OP put his EF in risky assets.

An EF is not a new car/home improvement/vacation fund. It may have been in the same account, but surely you isolated the EF from the rest and did not spend the EF when money from the account was spent on other things.

I don't disagree that's it's simpler to keep your EF in your checking account, but a few extra dollars can be picked up or saved by contributing his EF to her Roth.

[scubadiver]

An EF is not a new car/home improvement/vacation fund.

But it can be a retirement account.

I don't disagree that's it's simpler to keep your EF in your checking account, but a few extra dollars can be picked up or saved by contributing his EF to her Roth.

Just to be clear, I'm not recommending that the OP keep it in checking. We have a checking and savings account at the same institution and can transfer money from one to the other on-line 24x7. This enables us to earn a modest amount of interest on the savings. We also keep some in an interest earning money market account that I can write checks against and the remainder in CDs.

For the record, I don't really disagree with what you've said. I just think that given the sums of money we are talking about, the difference between a bad savings account (glass jar burried in back yard) and an optimal savings account (some form of Roth investment) are not all that significant.