Using tax advantaged for “emergency fund”

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pepperz
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Joined: Sun Jan 24, 2016 7:13 pm

Using tax advantaged for “emergency fund”

Post by pepperz » Mon Jun 29, 2020 10:10 am

Considering economic times I’d like to up our cash reserves by another 12 months expenses.

We have the following tax advantaged space open:
- HSA family ($7,100)
- Backdoor ROTH ($6,000)
- SEP IRA individual ($6,000)

Does it make sense to contribute to those accounts first and simply NOT invest the funds, so they essentially stay as cash?

I figure this way we get the tax advantage for 2020 AND ability to use the funds in the uncertain case of emergency.

Downside is there will be a penalty to withdraw these funds should we need to, however I’m not sure what the realistic chance of that is.

Opinions?

livesoft
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Re: Using tax advantaged for “emergency fund”

Post by livesoft » Mon Jun 29, 2020 10:15 am

The HSA can be withdrawn for medical expenses which might be the most likely emergency.

While I am not certain about the Roth 5-year-rule on conversions, do you have Roth contributions or conversions that have been in those accounts for at least 5 years? I think they can be withdrawn penalty-free and tax-free. Please get someone else to confirm that.

You didn't tell us much about your current emergency fund. If it is 2 years of expenses and you want to increase that to 3 years of expenses, then that would be different from having 2 months of expenses and increasing to 14 months of expenses. Nor did you tell us anything about what you have invested in equity or bond funds in a taxable account.
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02nz
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Re: Using tax advantaged for “emergency fund”

Post by 02nz » Mon Jun 29, 2020 10:16 am

pepperz wrote:
Mon Jun 29, 2020 10:10 am
Does it make sense to contribute to those accounts first and simply NOT invest the funds, so they essentially stay as cash?
You have until April of next year to fund IRAs and HSAs for 2020, so that's one way to cushion your emergency fund a bit without losing out on tax-advantaged space.

The HSA makes a particularly good secondary emergency fund, as long as you have receipts on hand for eligible expenses. If/when you need the money, just reimburse yourself, after all it doesn't matter if the expense was incurred 5 days or 5 years ago (ETA - as long as it was AFTER the HSA, or a prior HSA rolled over, was established).

You could keep in cash if you think there's a realistic chance you'll need to access those funds. Or, since you already have an emergency fund, consider this as part of your overall allocation, and allocate accordingly, in which case these accounts don't necessarily need to be kept in fixed income (cash/bonds).
Last edited by 02nz on Mon Jun 29, 2020 10:49 am, edited 3 times in total.

MotoTrojan
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Re: Using tax advantaged for “emergency fund”

Post by MotoTrojan » Mon Jun 29, 2020 10:20 am

Good plan. It makes the most sense to do this in a Roth that either has funds that were directly contributed as a Roth (not backdoor), or has funds that were converted from IRA to Roth (backdoor) over 5 years ago.

https://www.investopedia.com/ask/answer ... odroth.asp

In those cases, you can withdraw contributions without any penalty. So if you have some qualifying funds from past years, you could add your 2020 contribution now and then withdraw the old contributions (money is fungible, doesn't matter if you add to money market in 2020 and withdraw straight from money market) if an emergency arises.

Given how low money market yields are now though I would just leave it in taxable cash until April 2021 as you won't have much tax drag when you gain no interest anyways.

tonyclifton
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Re: Using tax advantaged for “emergency fund”

Post by tonyclifton » Mon Jun 29, 2020 10:22 am

02nz wrote:
Mon Jun 29, 2020 10:16 am
The HSA makes a particularly good secondary emergency fund, as long as you have receipts on hand for eligible expenses. If/when you need the money, just reimburse yourself, after all it doesn't matter if the expense was incurred 5 days or 5 years ago.
FYI...The reimbursement may only go back to the date the HSA was opened:
For HSA purposes, expenses incurred before you establish your HSA aren’t qualified medical expenses.
https://www.irs.gov/publications/p969

02nz
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Re: Using tax advantaged for “emergency fund”

Post by 02nz » Mon Jun 29, 2020 10:30 am

tonyclifton wrote:
Mon Jun 29, 2020 10:22 am
02nz wrote:
Mon Jun 29, 2020 10:16 am
The HSA makes a particularly good secondary emergency fund, as long as you have receipts on hand for eligible expenses. If/when you need the money, just reimburse yourself, after all it doesn't matter if the expense was incurred 5 days or 5 years ago.
FYI...The reimbursement may only go back to the date the HSA was opened:
For HSA purposes, expenses incurred before you establish your HSA aren’t qualified medical expenses.
https://www.irs.gov/publications/p969
Thanks, that's an important point to add.

tashnewbie
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Re: Using tax advantaged for “emergency fund”

Post by tashnewbie » Mon Jun 29, 2020 11:28 am

Is it fair to assume, because you're asking this question, that you can't max tax-advantaged accounts *and* beef up the EF?

If you can do both, obviously do that. Like someone else mentioned, you have until April 2021 to contribute to Roth IRA.

If you can't do both, then I would de-prioritize the SEP IRA contributions relative to the other accounts, because there's less flexibility on withdrawals. This assumes you already have direct Roth contributions or conversions that are at least 5 years old that you can withdraw from the Roth IRA, which would be penalty- and tax-free.

Olemiss540
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Re: Using tax advantaged for “emergency fund”

Post by Olemiss540 » Mon Jun 29, 2020 11:47 am

What other assets do you have currently? Any taxable funds available? How much cash on hand? Any previous Roth contributions available?
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retiredjg
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Re: Using tax advantaged for “emergency fund”

Post by retiredjg » Mon Jun 29, 2020 12:13 pm

I don't think that having cash in the SEP IRA is going to do you a lot of good because the list of exceptions to the penalty is not very broad - mostly medical expenses and paying for medical insurance while unemployed. In other words, to buy groceries and pay the house note with your SEP IRA withdrawal, you'd have to pay the penalty. Of course, if you are willing to pay the penalty, that would work.

https://www.investopedia.com/articles/r ... 111202.asp

The HSA, obviously, can be used for medical expenses but is not much use if you lose your job and just need money to live on.

The obvious place to do this is the Roth IRA and I think it is a reasonable idea for people just starting out who do it as a temporary measure (eventually building up a real emergency fund and then investing the cash in the Roth IRA).

If you have past direct contributions to Roth IRA, that money would be available any time with no penalty - you could put a chunk of Roth IRA money into short term bonds or cash to extend your emergency fund that way. Seems OK as a temporary measure, but I'm not sure I'd do that for years because I want my Roth account to grow.

As for your backdoor Roth contributions....if you contributed $5,500 and converted $5,500 to Roth, that money is available any time with no 5 year clock. If you contrbuted $5,500 and converted $5,600 ($100 earnings), you cannot get to the $5,500 without taking out and paying a penalty on the $100 first if the 5 tax year clock on that $100 has not finished running.

If you want to build up your cash reserves, I'd suggest just saving it. If you are making enough money to need the back door to put money into Roth, that seems like the most logical approach to me.

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whodidntante
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Re: Using tax advantaged for “emergency fund”

Post by whodidntante » Mon Jun 29, 2020 12:25 pm

My preference is to max a 401k, HSA, and backdoor Roth IRA every year and to throw anything that's left in taxable and to invest all of that money according to my desired asset allocation.

Sure, there's a chance that I'll lose my job, and actually that's sort of realized as I am getting furloughed in July. And there's a chance that I'll become disabled. And there's a chance my roof will rip off my house and land in the next county and that it will coincide with a horrific -50% bear market. But then, I'm an optimist. I like to take the path that can have a good result, instead of taking the defensive path with glaring disadvantages that will definitely be realized. It's a good risk if you ask me. I no longer worry about market losses because at this point I'm playing with the house's money and it's because I took good risks earlier, and got lucky.

Topic Author
pepperz
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Re: Using tax advantaged for “emergency fund”

Post by pepperz » Tue Jun 30, 2020 7:39 am

Thanks for the insights everyone... I did not consider that we have until April 2021 to make the HSA / ROTH / SEP contributions!

That means we could just keep the funds in our regular savings account and wait until next April to contribute for the tax benefit?

We have $50K “emergency fund” right now in high yield savings. This probably buys us ~12 months if income were to go away.

Normally I am comfortable with this but spouse and I are both self employed in unstable industries. 24 months buys more peace of mind and gives us time to dial something new in.

retiredjg
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Re: Using tax advantaged for “emergency fund”

Post by retiredjg » Tue Jun 30, 2020 8:11 am

pepperz wrote:
Tue Jun 30, 2020 7:39 am
That means we could just keep the funds in our regular savings account and wait until next April to contribute for the tax benefit?
That will give you an expanded emergency fund for now, but what are you going to do in April? What if things are still unstable then?

Sounds like your reason to expand your emergency fund is a good one. I'd be prepared to invest less for retirement and put more into the emergency fund if it comes to that.

simas
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Re: Using tax advantaged for “emergency fund”

Post by simas » Tue Jun 30, 2020 8:21 am

pepperz wrote:
Tue Jun 30, 2020 7:39 am
Thanks for the insights everyone... I did not consider that we have until April 2021 to make the HSA / ROTH / SEP contributions!

That means we could just keep the funds in our regular savings account and wait until next April to contribute for the tax benefit?

We have $50K “emergency fund” right now in high yield savings. This probably buys us ~12 months if income were to go away.

Normally I am comfortable with this but spouse and I are both self employed in unstable industries. 24 months buys more peace of mind and gives us time to dial something new in.
what is the definition 'emergency' (or emergencies) that you protecting against? loss of income for one or both of you? being at fault at bad accident and being sued for seven digit amounts? having a car breakdown and no transportation (which is an emergency for a lot of people)? having high unexpected medical expense?

for income replacement, yes - you can get to savings and pay penalties if it comes to it. for lawsuit, none of this would matter in any way (and you actually would want _more_ in protected accounts vs _less_ in case you have to declare bankruptcy), here things like umbrella liability insurance would be better idea.

match the risks with the tools you may use to address them..

I always put the most I can into the protected space as that space is once and done, if you missed the window for 2019 you will not get it back.

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