Why Choose Between Retirement Savings and an Emergency Fund? A Roth IRA Lets You Do Both

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The problem: You want to start saving for retirement but need to build up an emergency fund.

The solution: Use a Roth IRA as an emergency fund instead of a regular bank account.

Why do you need an emergency fund?

As a self-employed person, your emergency fund needs to be even bigger than is usually recommended to cover for slow periods of work, landlords wanting bigger deposits, and lenders wanting larger down payments.

What’s a Roth IRA?

A Roth IRA is a type of investment account primarily designed for retirement. When used for retirement, a Roth IRA lets you withdraw your investment gains tax-free because contributions were made with post-tax dollars.

For 2021, they’re available to individuals with incomes of less than $140,000 per year, and you can contribute up to $6,000 per year. If you’re above the Roth IRA income limits, this move isn’t available to you.

Why put your emergency fund in a Roth IRA?

Because there’s an annual contribution limit, you want to start contributing as soon as possible. You want the most money possible growing tax-free.

What if you need the money?

Just take it out. You can withdraw contributions without taxes or penalties. If you need to withdraw the earnings early, there’s a 10% penalty plus regular income taxes on those earnings.

Don’t you lose Roth space if you take the money out?

Due to Roth IRA limits, you can only contribute so much each year. If you take money out, you reduce how much you can have in your IRA over your lifetime.

  • For example, say you can put in $5,000 per year for 20 years. You’ll end up with $100,000 plus potential investment gains.
  • Now say you had to withdraw $10,000. At the end of 20 years, you’ll only have $90,000 worth of contributions in your account plus gains on the $90,000.
  • But, if you had put the $10,000 in a regular savings account to begin with, you never would have had a chance at the $100,000. So, if you think there’s a chance that you won’t need to touch the money and you aren’t maxing your Roth already, fill it up before you use a savings account.

Is it safe?

A Roth IRA is no more risky or less risky than other types of accounts. It all depends on what you invest in.

If you’re designating the money as emergency funds, many experts recommend that you only invest in money market funds, low-risk bonds, or CDs. Some people do choose to use conservative mutual funds or allocations of stock and bond ETFs. Avoid investments that have minimum holding periods to ensure fast access to your emergency funds at all times.

What if you want to invest more aggressively?

Using a Roth IRA as an emergency fund is a temporary solution while you build up your regular savings account. Add to your savings account once you’ve maxed out your Roth IRA contributions. When there’s enough money in your savings account to act as your emergency fund, you can reinvest your Roth IRA funds into growth-oriented investments.

What’s the best brokerage account for your emergency fund?

The first step is deciding what type of investments you want to use for your emergency fund. Not all brokerage accounts offer all types of investments. Of those that do, some may charge higher fees for that type of investment than the others.

Second, look at overall fees such as monthly maintenance fees or fees for having a balance below the minimum required balance. You can almost always find a good broker that doesn’t have these fees.

Finally, check customer service reviews. You can find many good reviews for the big brokers like (in alphabetical order) Fidelity, Merrill Edge, Schwab, and Vanguard.

How can you open a Roth IRA?

Opening a Roth IRA is very easy. It works just like opening a regular bank account. However, it is your responsibility to know whether you’re eligible to contribute. There are heavy tax penalties if you contribute when you’re not eligible or if you put too much money in.

You are allowed to have multiple Roth IRAs. However, the annual contribution limits are per person. Having two accounts doesn’t double your limit.

Need personal help? Click here for additional free resources or to find an accountant, attorney, or other professional near youRemember: This blog post and the comments provide generalized information that may be out of date or inaccurate for your situation. Always schedule a personal consultation with an appropriate licensed professional in your area before taking action. For full terms of use, click here.

Have general questions about this post or want to learn more about a related topic? Please leave a comment at the bottom of the page. Comments are public, and I can’t provide individual advice, but it helps me make the posts more useful for the future. Please do not post personal information. If you need personal assistance, please contact the relevant government agency or hire an appropriate professional near you.

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