Can You Use a Roth IRA as an Emergency Fund?

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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.

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.

You can only contribute to a Roth IRA if you’re within the income limits.

Filing Status202320222021
Single and Head of Household$138,000 to $153,000$129,000 to $144,000$125,000 to $140,000
Married Filing Jointly and Qualifying Widower$218,000 to $228,000$204,000 to $214,000$198,000 to $208,000
Married Filing Separately$1 to $10,000$1 to $10,000$1 to $10,000
If your income is up to the lower number, you can make a full contribution. Your contribution drops to $0 once you reach the second number.

If you’re above the Roth IRA income limits, this move isn’t available to you.

Why put your emergency savings 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.

This is actually a common retirement planning strategy.

What are the withdrawal rules if you need the money?

The answer to how to use your Roth IRA as an emergency fund is simple. Just take the money out when you need it. You can withdraw contributions without paying taxes or penalties. If you need to withdraw the earnings early, there’s a 10% penalty plus regular income taxes on those earnings.

Contributions to a Roth IRA always come out first. So if half of your Roth IRA balance is contributions, half is earnings, and you need half of your money, you’re only withdrawing contributions.

You don’t need to pay a penalty or tax on earnings if it’s been at least five years from your first contribution to your Roth IRA and you need the money because:

  • Any reason if you’re over age 59 1/2
  • You become permanently disabled
  • You’re a first-time homebuyer

You don’t need to pay a penalty but do pay tax on earnings if you need the money because:

  • You retire early and set up a series of substantially equal distributions
  • You have unreimbursed medical expenses that add up to more than 10% of your AGI
  • To pay for your health insurance after losing your job
  • The IRS imposes a levy for a tax debt
  • You have qualified education expenses

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 better to use credit cards than retirement savings?

You may think about putting an emergency expense on a credit card to avoid tapping into your retirement savings. You will usually only want to do this if you have a zero percent promotional interest rate. Otherwise, the credit card interest will probably be more than your tax savings and investment returns.

Is it possible to put the money back into your Roth IRA?

There is a way to put money back into your Roth IRA. If you quickly recover from your emergency, you have up to 60 days the put the money back in as if you never took it out. You can repay the full withdrawal or part of it. You can only do this one time per year.

Additionally, if you took out money you contributed during the current tax year, it doesn’t count towards your contribution limit for the current year. You can put that money back in under the usual contribution limits.

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?

If your savings plan will allow you to save more than your IRA limits in the future, using your 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.

Can you use this emergency fund strategy with traditional IRAs?

You can also use a traditional IRA as an emergency fund. The reason Roth IRAs get more is that you can withdraw contributions without paying taxes or penalties.

Since you get an immediate tax deduction for your traditional IRA contributions, you pay taxes and penalties on any money you withdraw early unless you have a qualified exception.

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.

Thanks for reading.

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