Robbing the emergency fund to start a Roth...?

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cathryn8
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Robbing the emergency fund to start a Roth...?

Post by cathryn8 »

Hey, everyone. Hope I'm doing this right. My husband and I are young (26 & 29) and just starting to figure out this investing business. Long story short: I'm a SAHM & he has been a federal employee for about 2 1/2 years; we just bought a house this summer, so now we're ready to stop stockpiling for a house down payment & start getting serious about investing our "extra" each month. We are complete noobies to investing and we're working hard to learn fast (we've got holds placed for Boglehead's Guide to Investing & Common Sense about Mutual Funds at the library, haha).

Since buying the house, we've just been increasing our contributions to his TSP (401k) account, but we're realizing that we need to work toward maxing out on Roths too (we can each do one even though I don't work, right?). He has a 5% employer match to his TSP; since buying our house, we've been contributing 15%-20% to the TSP. We're quickly wising up and have decided we want to start up a couple of Roths QUICK to get them in under the 2013 wire.

Here's our (tentative) long-term plan. Does this look right? (The percentages are supposed to be based on net income, not gross, right? Told you we were noobies...)
- 5% to TSP (401k), which is the employer match max
- 10% to Roths (at our current net, this is only about $5000 annually)
- up to another 3%ish for savings for the boys, short-term savings (for a minivan! Those are expensive!), etc.

Assuming that sounds ok, here's my actual question. We have about $17,000 cash in the bank right now (no debt besides the mortgage). How much do we need to cling to for an emergency fund, and how much can/should we dump into the Roths? We had been thinking it would be good to keep about $10k tucked away for the emergency fund (which is about 4 months of comfortable living expenses), but now I'm starting to wonder if it would be wiser to "rob" about $5000 from that to max out our Roth contributions for 2013 and then slowly regenerate the rest of the emergency fund throughout 2014. My thinking is that the remaining $5000 is plenty to cover a dire emergency, and if my husband were to face a job loss, I have the ability to go back to work almost immediately & bring in enough to stretch things out for a few more months. We have family resources we could draw on too, if we had to (although that's obviously not ideal).

Our (tentative) short-term goal is to max out our Roth contributions for 2013 and 2014 (which would mean pretty lean living next year and not putting much in short-term saving, but we've certainly done it before) and then after that to just contribute 10% of our income to them, eventually up to the Roth max. We're motivated to get a tidy little lump in there ASAP because we know the power of letting that grow & compound over time. But is it unwise to (temporarily) cut into our emergency fund to jump-start our Roths?

Thanks in advance!
ajcp
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Re: Robbing the emergency fund to start a Roth...?

Post by ajcp »

cathryn8 wrote: Since buying the house, we've just been increasing our contributions to his TSP (401k) account, but we're realizing that we need to work toward maxing out on Roths too (we can each do one even though I don't work, right?).
Yes, as long as you file jointly, which I'm assuming you do.
cathryn8 wrote: We're quickly wising up and have decided we want to start up a couple of Roths QUICK to get them in under the 2013 wire.
You can actually contribute to a 2013 IRA until April 15th, so although it shouldn't put it off too long, you do have some time.
cathryn8 wrote: Here's our (tentative) long-term plan. Does this look right? (The percentages are supposed to be based on net income, not gross, right? Told you we were noobies...)
- 5% to TSP (401k), which is the employer match max
- 10% to Roths (at our current net, this is only about $5000 annually)
- up to another 3%ish for savings for the boys, short-term savings (for a minivan! Those are expensive!), etc.
They're not "supposed" to be on anything, it can be whatever you want. Obviously the more you save the better.
cathryn8 wrote: Assuming that sounds ok, here's my actual question. We have about $17,000 cash in the bank right now (no debt besides the mortgage). How much do we need to cling to for an emergency fund, and how much can/should we dump into the Roths? We had been thinking it would be good to keep about $10k tucked away for the emergency fund (which is about 4 months of comfortable living expenses), but now I'm starting to wonder if it would be wiser to "rob" about $5000 from that to max out our Roth contributions for 2013 and then slowly regenerate the rest of the emergency fund throughout 2014. My thinking is that the remaining $5000 is plenty to cover a dire emergency, and if my husband were to face a job loss, I have the ability to go back to work almost immediately & bring in enough to stretch things out for a few more months. We have family resources we could draw on too, if we had to (although that's obviously not ideal).

Our (tentative) short-term goal is to max out our Roth contributions for 2013 and 2014 (which would mean pretty lean living next year and not putting much in short-term saving, but we've certainly done it before) and then after that to just contribute 10% of our income to them, eventually up to the Roth max. We're motivated to get a tidy little lump in there ASAP because we know the power of letting that grow & compound over time. But is it unwise to (temporarily) cut into our emergency fund to jump-start our Roths?
That's really up to you and your situation. One option you have is that you can withdraw Roth IRA contributions at any time, tax and penalty free. It's not a habit that you want to get into, but it is an option. And if the alternative is a smaller contribution in 2013 anyway, you wouldn't be any more behind if you put it in and withdrew it. But once you withdraw it you can't put it back. There's also the risk that the roth goes down between when you invest it and when the emergency occurs. One safe alternative could be to buy an ira cd with your emergency fund portion. You won't get much interest, but you'll reserve that portion of the 2013 contribution limit. Then when you build back up your emergency fund you can put it in something riskier.
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Taylor Larimore
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Re: Robbing the emergency fund to start a Roth...?

Post by Taylor Larimore »

Cathryn:

Welcome to the Bogleheads Forum!
Robbing the emergency fund to start a Roth?
This is an earlier post I wrote on the subject:
Emergency Fund definition: "Cash set aside in a dedicated interest account to cover unanticipated emergencies such as property repairs, medical expenses and car repairs."--Financial Glossary

In my opinion, most investors do not need a separate "Emergency Fund" as described above. What we need is a "source" of ready cash--not necessarily another separate, low-yielding account (other than a checking account).

Pat and I have not had a separate "Emergency Fund" for many years. Like most Bogleheads, we know that if it becomes necessary, we can get money from our checking account, portfolio, credit card, bank, home equity loan, life insurance, family, etc.

For young working investors, a Roth IRA can be an excellent emergency fund with all contributions available at any time without tax or penalty. Of course, no one likes to take emergency funds from a retirement account, but if it is necessary (and may never be), its better than delaying the start of a Roth with tax-free compounding.

For older investors, with sizable retirement portfolios, emergency funds are normally no problem.

In my opinion, the idea that everyone must have a separate "emergency fund" is an investing myth.
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
spaddlewit
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Re: Robbing the emergency fund to start a Roth...?

Post by spaddlewit »

Just recently, the feds also started offering a Roth TSP. So that might be another option for you, if you also want to Rotherize your TSP contributions.

Personally, since Roth IRA *contributions* can be withdrawn at any time, I'd say raid the emergency fund and put it in the Roth. You can always pull it out later if there's an emergency.
joelly
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Re: Robbing the emergency fund to start a Roth...?

Post by joelly »

We're going to do the same thing, raid our emerg fund to max 2013 roth.
Geist
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Re: Robbing the emergency fund to start a Roth...?

Post by Geist »

cathryn8 wrote:Assuming that sounds ok, here's my actual question. We have about $17,000 cash in the bank right now (no debt besides the mortgage). How much do we need to cling to for an emergency fund, and how much can/should we dump into the Roths? We had been thinking it would be good to keep about $10k tucked away for the emergency fund (which is about 4 months of comfortable living expenses), but now I'm starting to wonder if it would be wiser to "rob" about $5000 from that to max out our Roth contributions for 2013 and then slowly regenerate the rest of the emergency fund throughout 2014. My thinking is that the remaining $5000 is plenty to cover a dire emergency, and if my husband were to face a job loss, I have the ability to go back to work almost immediately & bring in enough to stretch things out for a few more months. We have family resources we could draw on too, if we had to (although that's obviously not ideal).
The old "rob Peter to pay Paul" scenario, huh? :wink:

Actually, in this case it's not such a bad idea. Certainly, you would want to avoid depleting your EF, but remember than Roth IRA contributions *can* be withdrawn without penalty if necessary. So what you could do is move the EF money into your Roth IRA, then keep it in a relatively safe investment (such as a short-term bond fund?) until you are able to build up the missing cash back into your actual EF. Once you have your full EF good to go, then you can move around the money in the Roth to whatever else your AA directs you toward.

Just a separate question, since you don't seem to explain this.... If you have $17k in cash, want to set aside $10k as your EF, and need $5k to fund a Roth IRA, what do you have planned for that other $7k? As I see it, you could keep your $10k EF, pull $5k for the EF, and still have $2k in "other" cash available. Bottom line, money is fungible... If that $7k isn't earmarked for future spending already, use it to your advantage.

3 more points, just to clarify:
- The current Roth IRA contribution maximum is $5,500/yr. So if your goal is to max out the Roth, you'll need more than $5k.
- Even though you are a SAHM without a regular income (I won't insult you by saying that you "aren't working"), you can still open & fund a spousal Roth IRA for yourself, qualified upon your husband's income for your joint household. So really, you can contribute up to $11k this year (if desired) between both of your Roth IRAs.
- Net vs. gross income is a personal choice, and you'll get different opinions from anyone you ask. Myself, I find gross income to be more useful, because there are expenses & such that all come out of your gross income and are not really represented by using net -- taxes (which can change based on your withholding), FICA, life/health insurance, 401k/TSP contributions (also adjustable), etc. But certainly those things are impacting your bottom line, so I find it simpler to account for all of those things & just use gross income. But in the end, it's up to you.
PS241
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Re: Robbing the emergency fund to start a Roth...?

Post by PS241 »

OP has very nearly the same situation as ours albeit a few years older and appears to be payed slightly more. For ourselves, I think we will hold our emergency fund in traditional bank accounts. Why?.. we are not close to maxing tax advantaged accounts so I am not worried about "saving" the space, and the money is not "safe" enough for me being invested with a young family that could have many different types of emergencies. Ask yourself would you be as tempted to do this if the market was down 30% this year instead of up?

All that being said, I do agree with others that as net worth goes up, need for a traditional emergency fund goes down.
Caduceus
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Re: Robbing the emergency fund to start a Roth...?

Post by Caduceus »

Yes, I would contribute to the Roth even if it means using up your emergency fund. You're not really "robbing" from anything. Since the contributions (but not the earnings on those contributions) into a Roth can be withdrawn penalty-free, you're just switching up the location of your funds. You have nothing to lose except possibly a little paperwork if you end up having to use the money in the Roth during an emergency.

And you have a great deal to gain if you end up not needing to withdraw from the Roth.
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carorun
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Re: Robbing the emergency fund to start a Roth...?

Post by carorun »

I am 27, and I *sorta* did this. I always keep a few k in my savings account and Roth-erize the rest. I have not needed to pull any funds out yet, as most emergencies or large purchases for me can be taken care of with a combo of savings, monthly cash flow, and credit cards (I don't carry a balance). You can withdraw contributions at any time, and I understand if you pull out funds for the current year, you can still replace them the same year. So if you deposit 2k in January but withdraw it for an emergency in March, you have till December (or maybe the following April) to replace the funds.

If you are going to move some of your emergency fund to a Roth, I would keep it in conservative investments. I keep about 2 months of expenses in a bond fund (FBIDX) and the rest is in a total stock market fund. That also doubles as my portfolio's bond allocation.
HopeToGolf
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Re: Robbing the emergency fund to start a Roth...?

Post by HopeToGolf »

Using the Roth instead of building emergency funds is something we did as we were accelerating our savings (maxing out on tax deferred contributions) and dealing with large expenses.

For us, the question was what emergencies were we contemplating. Replacing a water heater was an "emergency" but that was paid out of general savings (new car, home repair/renovation, unexpected dental work, etc.). I guess when we thought about the emergency fund we thought about it almost as a job loss (or unforeseen financial catastrophe) fund.

The Roth was a great place for the funds since you can withdraw the contributions without penalty. Fast forward a few years and now IBonds and CDs house the emergency funds sort of. Like Taylor, our funds are commingled so in an emergency, it is all hands (accounts) on deck and we would start withdrawing from the account(s) with the least damaging investment and tax consequences.
Mike Scott
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Re: Robbing the emergency fund to start a Roth...?

Post by Mike Scott »

Is the following true?

"You can withdraw contributions at any time, and I understand if you pull out funds for the current year, you can still replace them the same year. So if you deposit 2k in January but withdraw it for an emergency in March, you have till December (or maybe the following April) to replace the funds."
TSR
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Re: Robbing the emergency fund to start a Roth...?

Post by TSR »

I agree with everyone that this year's plan (which you have until April to implement) should definitely include maxing out the Roth space to use as a sort of quasi emergency fund. I want to press you a bit on whether you should necessarily have that as your "long-term" plan as well though. There is a lot of debate on whether one should prioritize a traditional 401k (like the TSP) or a Roth, and you should do some reading on it here and elsewhere* (http://www.bogleheads.org/wiki/Roth_vs._Traditional). I'm not saying you will change your mind, but I want to make sure you guys understand why you're doing what you're doing. Regardless, the following three things are true: (1) the TSP is an awesome program with exceptionally low fees and access to the amazing G Fund, (2) you two could probably use the extra cash that you would be saving on taxes by prioritizing the TSP now, and (3) although you understandably can't do it right now, you will want to work toward one day maximizing both. Again, I don't disagree with your plan, but it is good to make sure you have an articulable reason for doing what you're doing.

*Be sure to consider whether the taxable-income-lowering effect of the TSP would bring your income down to the point where you can take advantage of certain tax credits/deductions, like the student loan interest deduction.
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Re: Robbing the emergency fund to start a Roth...?

Post by YttriumNitrate »

You have three and a half months before the deadline for 2013 Roth contributions (around April 15th 2014). I'd suggest waiting until closer to the deadline to make the contribution so that you don't have to take as much from your emergency fund.

You can withdraw your contributions from the Roth. However, since you are still in your early 20s, a good chunk of the money you put into your Roth will probably get invested in stock index funds (hopefully) which in renders it unfit to function as an emergency fund in my opinion.
pingo
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Re: Robbing the emergency fund to start a Roth...?

Post by pingo »

Mike Scott wrote:Is the following true?

"You can withdraw contributions at any time, and I understand if you pull out funds for the current year, you can still replace them the same year. So if you deposit 2k in January but withdraw it for an emergency in March, you have till December (or maybe the following April) to replace the funds."
Once some money was mistakenly placed in a Roth and Vanguard pulled it back out a few days later to correct the issue (I don't remember if it was my fault or theirs), so I asked if that was going to hurt my Roth max for that year. The rep explained the same thing to me (or something very close to it). However, I don't know where one would go to verify it in print.
mlipps
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Re: Robbing the emergency fund to start a Roth...?

Post by mlipps »

We did this last year. If you're worried about investing your emergency fund, you can contribute to a Roth IRA at Ally or other internet banks and put the money into a CD. Then, when your emergency fund outside the Roth is larger, you can roll the money over to Vanguard or another brokerage firm and invest it according to your asset allocation.
ajcp
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Re: Robbing the emergency fund to start a Roth...?

Post by ajcp »

Mike Scott wrote:Is the following true?

"You can withdraw contributions at any time, and I understand if you pull out funds for the current year, you can still replace them the same year. So if you deposit 2k in January but withdraw it for an emergency in March, you have till December (or maybe the following April) to replace the funds."
Yes, taking out funds basically resets the limit. So if you withdraw 2013 money, you have until April to put it back. If you withdraw 2012 money, it's too late since that deadline was 8 months ago.
placeholder
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Re: Robbing the emergency fund to start a Roth...?

Post by placeholder »

PS241 wrote:For ourselves, I think we will hold our emergency fund in traditional bank accounts. Why?.. we are not close to maxing tax advantaged accounts so I am not worried about "saving" the space, and the money is not "safe" enough for me being invested with a young family that could have many different types of emergencies.
You're missing the point that a Roth is just a container so you can have the EF in there without risking it by putting it in CD or MM fund to preserve the space.
pingo
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Re: Robbing the emergency fund to start a Roth...?

Post by pingo »

^ Nice imagery. Banks and other firms all have these containers lying around for you to use them within regulatory limits. You choose what you want to go into the container. Banks offer certain options to put in the container, firms offer others. You can even use many different containers, so long as you don't exceed the combined amount allowed by law.
realityinabox
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Re: Robbing the emergency fund to start a Roth...?

Post by realityinabox »

placeholder wrote:
PS241 wrote:For ourselves, I think we will hold our emergency fund in traditional bank accounts. Why?.. we are not close to maxing tax advantaged accounts so I am not worried about "saving" the space, and the money is not "safe" enough for me being invested with a young family that could have many different types of emergencies.
You're missing the point that a Roth is just a container so you can have the EF in there without risking it by putting it in CD or MM fund to preserve the space.
Sorry if this is a newb question, but what you mean by "saving the space"? I had thoughts of doing what the OP suggested; I have about $11k in my checking account that is earmarked as emergency fund, and had thoughts of throwing it into my Roth to max out my 2013 contribution.

As I think this through, it seems like you are saying that rather than putting the new contribution taken from the emergency fund into something volatile like a stock index fund, one could put the new contribution into CD or Money Market, then once the cash in the checking account is rebuilt, the money in the CD or MM could be transferred into the stock index fund, thus maxing the Roth contribution while limiting the risk against the emergency fund. Is this correct?
ajcp
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Re: Robbing the emergency fund to start a Roth...?

Post by ajcp »

realityinabox wrote: Sorry if this is a newb question, but what you mean by "saving the space"? I had thoughts of doing what the OP suggested; I have about $11k in my checking account that is earmarked as emergency fund, and had thoughts of throwing it into my Roth to max out my 2013 contribution.
Sounds like you understand it correctly. You can only contribute 5500 per person per year to an ira, and if you haven't contributed for 2013 by April, you'll never be able to put that money in later.
realityinabox
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Re: Robbing the emergency fund to start a Roth...?

Post by realityinabox »

ajcp wrote:
realityinabox wrote: Sorry if this is a newb question, but what you mean by "saving the space"? I had thoughts of doing what the OP suggested; I have about $11k in my checking account that is earmarked as emergency fund, and had thoughts of throwing it into my Roth to max out my 2013 contribution.
Sounds like you understand it correctly. You can only contribute 5500 per person per year to an ira, and if you haven't contributed for 2013 by April, you'll never be able to put that money in later.
Would this strategy still be beneficial if I am not sure whether I will be able to contribute the maximum amount in 2014 and I earn 3% on my checking account? Long story short, I'm back in school studying engineering, so income and expenses can be erratic at times. Not sure that I feel comfortable putting the emergency fund into stocks, etc, considering. I have a year and a half left in school, so keeping the money in the Roth in a MM (or other low/no risk fund) for that long is feasible, though I'm not sure how to value missing out on the 3% from the checking account against having those funds available in the Roth later on. I have a feeling that forgoing the 3% is the smarter choice in the long run, but that is a feeling, not based on any sort of math.
ajcp
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Re: Robbing the emergency fund to start a Roth...?

Post by ajcp »

realityinabox wrote:
ajcp wrote:
realityinabox wrote: Sorry if this is a newb question, but what you mean by "saving the space"? I had thoughts of doing what the OP suggested; I have about $11k in my checking account that is earmarked as emergency fund, and had thoughts of throwing it into my Roth to max out my 2013 contribution.

Sounds like you understand it correctly. You can only contribute 5500 per person per year to an ira, and if you haven't contributed for 2013 by April, you'll never be able to put that money in later.
Would this strategy still be beneficial if I am not sure whether I will be able to contribute the maximum amount in 2014 and I earn 3% on my checking account? Long story short, I'm back in school studying engineering, so income and expenses can be erratic at times. Not sure that I feel comfortable putting the emergency fund into stocks, etc, considering. I have a year and a half left in school, so keeping the money in the Roth in a MM (or other low/no risk fund) for that long is feasible, though I'm not sure how to value missing out on the 3% from the checking account against having those funds available in the Roth later on. I have a feeling that forgoing the 3% is the smarter choice in the long run, but that is a feeling, not based on any sort of math.
The idea is that if you miss a year you can't make it up later because there are limits, so if those limits don't affect you, then there's no hurry. I don't come close to maxing out my 401k, so I don't worry about missing out on that space, because I know I won't be able to max it next year either, so if I get some extra funds I can do it then.
dcfas
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Re: Robbing the emergency fund to start a Roth...?

Post by dcfas »

A question and perhaps a tip of the hat to paranoia: Are any vehicles that may be held within a Roth FDIC insured? The idea of using a Roth as an EF sounds perfectly logical to me if allocated safely, otherwise.

Cheers
pingo
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Re: Robbing the emergency fund to start a Roth...?

Post by pingo »

You can open an IRA at a bank or credit union and put the money in a CD. PenFed comes to mind for their CDs...
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