Building Emergency Fund within Roth IRA

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brown3218
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Building Emergency Fund within Roth IRA

Post by brown3218 »

I've read this wiki link about one way to use your Roth as an emergency fund. http://www.bogleheads.org/wiki/Roth_IRA ... gency_fund

My situation is a little different then the one described in the wiki link above. I'm married, no kids, my wife and I are both 25. I am currently saving up to the employer match in my 401k. I put 7% in, they fully match the 7%, plus throw an additional 10% in each year. Right now I have a small emergency fund saved, only about a month's worth of expenses. We aren't currently in the position to save too much more for retirement, and we aren't taking advantage of this large space of qualified retirement savings. I realize I should be saving cash for an emergency fund. There will be a point in the next few years where our income will grow substantially (wife is in pharmacy school). My thought is that I might as well build my emergency fund in the Roth IRA, rather than a taxable account, as I'll never be able to go back in time and contribute to my IRA. Is this a wise thing to do? Also, assuming that it's a good idea to have the emergency fund in the IRA, should I keep it fully in cash or would it be a good idea to look at something just a hair more aggressive?
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mhc
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Re: Building Emergency Fund within Roth IRA

Post by mhc »

I think you are understanding the importance of not wasting tax advantaged savings. Putting your emergency fund in a Roth is a great idea.

The key to an emergency fund is to really have plans in place on how to handle potential emergencies. There are many ways to raise emergency funds. Savings for retirement is only one of many options for handling an emergency. If the Roth will be your primary means for handling an emergency, you want to make sure you will have enough available to handle a potential emergency. The largest emergencies are probably job loss and/or unexpected medical expenses. Since equities can drop dramatically (e.g. 50% loss), you need something to provide stability for the emergency fund part of your savings (e.g., bonds, cash, cd's). It would be quite reasonable to have a larger allocation to low risk savings so that you could handle an emergency.

For example, if you have $50k saved, a 80/20 AA, and want a $10k emergency fund then:
$40k ($50k-$10k) invested according to AA ($32k/$8k)
$10k in stable investment
$50k: split $32k/$18k

Initially, the Roth would need to hold enough to handle the potential emergency. If equities end up in the Roth as part of your overall investment plan, then I would probably discount equities by 50% in their ability to handle an emergency. For example, if you want $10k for emergencies and you have $15k in Roths, then you could go $5k bonds and $10k equities. This way if equities drop 50%, you would still have your $10k available in the roth.
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mlipps
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Re: Building Emergency Fund within Roth IRA

Post by mlipps »

I don't see how your situation varies much at all from the wiki. I'm a big fan of "holding" Roth space in this way, and I think your plan sounds great.
livesoft
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Re: Building Emergency Fund within Roth IRA

Post by livesoft »

Yes, contribute to your Roth.

Yes, use something a hair more aggressive. I would suggest VCSH or VFSTX.
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brown3218
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Re: Building Emergency Fund within Roth IRA

Post by brown3218 »

mlipps wrote:I don't see how your situation varies much at all from the wiki. I'm a big fan of "holding" Roth space in this way, and I think your plan sounds great.
I just scanned the wiki but it looked like this was talking about how to transition an emergency fund from taxable to Roth, whereas in my situation I am essentially building the emergency fund for the first time within the Roth itself. It seemed like it would work, but I just wanted a second opinion.
gt4715b
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Re: Building Emergency Fund within Roth IRA

Post by gt4715b »

If you don't have funds to otherwise fill the Roth IRA it seems like a no-brainer to have your emergency fund in the Roth. I would invest pretty conservatively to start, like the Vanguard Retirement Income fund that's 30% stocks. That way even if stocks drop 50% you're only looking at a 15% drop in the Roth account value. Then over time as your assets grow you can become more aggressive.
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Jay69
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Re: Building Emergency Fund within Roth IRA

Post by Jay69 »

I did the same thing this year, I filled a Roth for 2012 and 2013. When 2014/2015 rolls around a good chunk of the EM fund will be in the Roth.

I plan to keep about 1/3 of the EM fund in checking with 2/3 in the Roth for now, 10k in checking/20k in the roth.

Any left over funds get tossed into I-bonds, I expect after the next 2 years or so that will be equal to my Roth EM fund, after the year wait time for I-bonds is over the Roth becomes part of the retirement plan and the I-bonds will be the EM fund.

We also have a car/house fund that we toss some $ into every month as well, I could use that to offset the I-bond wait time, something about many roads to ????. Just another way to look at it.

Another vote for VCSH
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brown3218
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Re: Building Emergency Fund within Roth IRA

Post by brown3218 »

Just a question on VCSH. At my brokerage firm it would cost me $8 per transaction for this ETF. It looks like this fund has an average duration of 3 years.

I pulled up another short term corportate bond fund that also has a duration of three years: THOPX. 5 star rated. http://finance.yahoo.com/q/pm?s=THOPX+Performance

The performance historically has been great, and it have never had a bad 3 year period. I wouldn't have any transaction costs if I bought this fund. Is this appropriate for a emergency fund? I realize the ER is much higher than VCSH.
livesoft
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Re: Building Emergency Fund within Roth IRA

Post by livesoft »

Switch brokerage firms today. LIfe is too short to waste money in a substandard brokerage firm.
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Topic Author
brown3218
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Re: Building Emergency Fund within Roth IRA

Post by brown3218 »

livesoft wrote:Switch brokerage firms today. LIfe is too short to waste money in a substandard brokerage firm.
Can't do that in my case.
fcox85
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Re: Building Emergency Fund within Roth IRA

Post by fcox85 »

Keep in mind that if you are worried about security or loss of funds, you can always shelter your Roth in a basic Savings Account at an institution like Ally Bank. In the future, when your income increases, and you are able to replenish a basic EF, you can simply roll over the Ally Roth to an institution like Vanguard, and invest in mutual funds. This would allow you have a "place holder" Roth with little or no risk of lost funds.

Also, if you are building the fund for the first time, this would avoid the problem of any minimum deposit requirements on a lot of mutual funds, so you could go ahead and get started.
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telemark
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Re: Building Emergency Fund within Roth IRA

Post by telemark »

This is one of the few investing decisions for which there is no actual down side. If you have an emergency and need the money you can withdraw the basis and you're no worse off than before. In the happier case (no emergency) you're preserving tax-sheltered space that you can use to advantage in the future.

The point of an emergency fund is to deal with emergencies. Emergencies are inherently unpredictable, so it needs to be safe and liquid. To me, this means a savings account or possibly a breakable CD ladder. If you feel tempted to reach for yield, consider using it as an opportunity to be more aggressive in your 401K.
Tabulator
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Re: Building Emergency Fund within Roth IRA

Post by Tabulator »

What about using BulletShares or other short-term fixed income funds available commission-free? Is that a good idea?
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telemark
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Re: Building Emergency Fund within Roth IRA

Post by telemark »

multivoiced wrote:What about using BulletShares or other short-term fixed income funds available commission-free? Is that a good idea?
BulletShares appears to be high yield corporate bonds, roughly the same risk level as stocks. There may be a place for these in an investment portfolio, but I don't think they're a good choice for an emergency fund.

The problem with using risky assets in an emergency fund is that you may have to withdraw money without warning. This is actually two problems: if the market is down the money may not be there, and even if it is you still have to sell at a loss. If you have a 401K with a stable value fund, you can try the approach described in Placing Cash Needs in a Tax-Advantaged Account, using the Roth instead a taxable account. This avoids the problem of selling at a loss since you would just rebuy the same asset class in the 401K.
Tabulator
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Re: Building Emergency Fund within Roth IRA

Post by Tabulator »

telemark wrote:
multivoiced wrote:What about using BulletShares or other short-term fixed income funds available commission-free? Is that a good idea?
BulletShares appears to be high yield corporate bonds, roughly the same risk level as stocks.
I should have been more specific. I was actually referring to the BulletShares investment-grade corporate bonds, not the high yielders.
crowd79
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Re: Building Emergency Fund within Roth IRA

Post by crowd79 »

The problem using a Roth IRA as an EF is what if the market dives within the next 5 years and an emergency comes up, them you're forced to liquidate your contributions including losses, you've effectively wiped out the entire account. EF in Roths should only be in a bank IRA CD, imo.
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Jay69
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Re: Building Emergency Fund within Roth IRA

Post by Jay69 »

crowd79 wrote:The problem using a Roth IRA as an EF is what if the market dives within the next 5 years and an emergency comes up, them you're forced to liquidate your contributions including losses, you've effectively wiped out the entire account. EF in Roths should only be in a bank IRA CD, imo.
Don't buy an asset that's going to dive :wink: For myself I have used my EM fund one time in the 20 years we have had it, I willing to take a gamble on a short term bond fund. The chances are I will pull it out slowly (job loss), hence it may recover.

If a short term bond fund is to much risk, I see nothing wrong with a CD's in a Roth, the way I see it, its a preservation of tax advanged space that you are taking the gamble on, its almost a free lunch in this case.
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