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I have been thinking about putting my emergency fund into a Roth IRA (in an FDIC insured High Yield Savings Account, so liquidity isn't an issue). My reasoning is as follows:

  1. I can always withdraw my contributions without a penalty.
  2. The interest payments (which I can't withdraw) are not a major contribution to my emergency savings
  3. I cannot fully fund a retirement account and build up a large enough emergency fund at the same time right now, so by putting the money in a taxable account, I will lose the opportunity for the tax savings forever. On the other hand, if, in the future, I can afford to save above the Roth contribution limits, I can use the extra money to start a new emergency fund, and invest some of the old one.

Are there any reasons why I shouldn't go ahead with this?

  • I am starting with the assumption that until my emergency fund reaches a significant size, I should be focusing all of my savings into building it (I have no outstanding debt with a significant interest rate, and no option of a 401K match) before I start saving for retirement. – lzam Jun 15 '17 at 13:09
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It's a little extra hassle come tax-time if you have a distribution to account for, as you'd be required to file Form 8606. If you pay for tax-preparation the extra fees could easily wipe out any interest earned.

Roth IRA savings accounts don't seem to earn much interest, so while you could come out slightly ahead with this approach, I don't think it's worth it. I prefer to keep a portion of my emergency fund in an online savings account (0.75% interest), and another portion in CD's (2.10% interest) through the same bank.

  • It isn't really the tax savings on the interest I am after. It's mainly the option of repurposing the money for investment if I end up being able to save more than the maximum Roth IRA contribution in the future (using the extra money for a new, taxable, emergency fund). – lzam Jun 12 '17 at 22:30
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    @Izam Well, the only tax savings available are on the interest, but I get what you're saying, it's not the short-term interest you're interested in but the long-term tax savings on interest if you're able to invest those funds later. That makes sense, but I still thought it not worth the hassle. I focused on the rates because I think of my emergency fund as money that has good odds of being spent at some point. If you think your emergency fund is likely to go untouched and it will be a while a few years before you can switch to investing, then I think the Roth IRA plan could be worth it. – Hart CO Jun 12 '17 at 22:50
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This is a great idea and I can't think of any downside. The best part about it is in the future when you have built up your emergency fund beyond the maximum contributions to the Roth IRA, you can then move your Roth funds into a higher yielding investment.

I might take it a step further. In addition to this, try to get a line of credit from your bank (with no annual fee). In case of emergency, you can decide if you want to take the money from your Roth or borrow from the line and pay some interest temporarily. Depending on the situation it may actually make sense to pay a little bit of interest and leave the money in the Roth, since over the long run the future earnings of that money could easily make you more than the interest you'll pay for (let's hope) a short amount of time.

To really hit home why your idea is fantastic:

  • If you ever have an emergency and need to pull all of the money out of your Roth IRA, you are no worse off than if you didn't open the IRA to begin with.
  • If you don't have an emergency and are later able to build up a separate emergency fund, you are much better off with more money in the Roth IRA.
  • To the DVer, I'm guessing you can think of a downside? Please share. It's been days and I still can't think of one. – TTT Jun 15 '17 at 15:37
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The biggest problem is what happens when you make a withdrawal if an emergency occurs. If the money was a contribution from a past year, you will not be able to put those funds back into the fund until a later date.

Assume the following scenario:

  • Annual income $60,000, and the goal for emergency fund is $30,000
  • 2017 deposit $5,500
  • 2018 deposit $5,500
  • 2019 deposit $5,500
  • in late 2020 an emergency happens, and you need to withdrawal $10,000. The balance in your Roth IRA is $16,500 in contributions and $1,500 in gains.
  • You remove $10,000 in contributions. Now you only have $6,500 in contributions.
  • You fight with the insurance company and in May 2021 they send you a check for $10,000.
  • you can put $5,500 in for 2021
  • you have to wait until January 2022 to put back the last $4,500.
  • You have lost the opportunity for retirement savings for 2017, 2020, and most of 2018.

The limits regarding maximum annual contribution and windows when you can contribute make this an inefficient way to operate the emergency fund/retirement fund.

Retirement and emergency funds are both important. Don't co-mingle them, it leads to double counting the money when you guesstimate where you are regarding your financial goals.

  • 2
    Hang on. If my goal is $30,000 and I don't put any of my emergency fund in a Roth IRA, I wouldn't be putting any money into retirement savings until 2022 anyway. Or are you suggesting I prioritize saving for retirement before I reach my emergency fund goal? – lzam Jun 15 '17 at 13:17
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    This answer seems to miss the point of the question. OP isn't asking if it's a good idea to tap into the IRA in case of emergency. If OP doesn't move the emergency fund into an IRA, there is no IRA to tap at all. – TTT Jun 15 '17 at 15:34
  • @TTT I think that mhoran does understand, and still thinks that it's a bad idea. – RonJohn Jul 1 '17 at 3:17
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    @RonJohn - that may be true, but if so, then the entire answer except for the last paragraph is pointless. The argument in this answer is that if an emergency occurs you won't be able to have as much money in the IRA. But the alternative is putting money in a bank account, and in that case there is exactly $0 in the IRA, which is even worse than the example here. – TTT Jul 1 '17 at 15:33
  • @Izam, the standard rule for e-fund vs. retirement is to quickly build a $1K efund and then balance your deposits into efund and retirement. (I actually don't have a specific "e-fund", but follow the YNAB dictum of giving every dollar a task. If for example I lose my job, then after we empty the Job Loss Fund, we'd take from the Vacation Fund, Auto Fund, etc.) – RonJohn Jul 2 '17 at 22:34

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