An investor came to us asking about using a Roth IRA as an emergency fund since Roth IRAs allow you to withdraw your contributions at any time, tax- and penalty-free. She was starting over at age 45 and didn’t want to miss the opportunity to save for retirement, but money is tight.
While we applaud her thought process, we believe that IRA money—Traditional or Roth—should be considered locked up until age 59 ½. These are funds you are saving for retirement and not a piggy bank.
It’s true that Roth IRAs are flexible regarding withdrawals. Several exceptions permit you to withdraw funds before age 59 ½ without penalties, such as for a first-time home purchase, qualified education expenses, unreimbursed medical expenses, and birth or adoption expenses. Note that each of these examples comes with qualifications and caveats. However, just because you can withdraw funds doesn’t mean you should.
When starting over after a divorce, death, or other catastrophic situation, the advice is primarily the same as it is for a beginner investor. At age 45, saving for retirement is certainly a priority. We recommend first contributing to your employer’s 401(k) plan enough to receive the full employer match. Even if your employer’s plan has a vesting schedule, your contributions are always yours. If you leave for another job in a year, you will likely receive some of the employer match. If the plan doesn’t have a vesting schedule, those employer contributions are yours to take with you.
Another top priority is establishing your emergency fund. Having access to emergency money was this investor’s initial reason for considering a Roth IRA; however, we recommend emergency money be in very liquid investments, like an interest-bearing checking account, money market funds, or short-term savings bonds. The return on these investments may be lower than growth investments, but you want emergency money shielded from market volatility. You want to know it will be there when you need it.
After establishing your emergency fund, saving to a Roth IRA is a sound plan. Provided your income is less than $146,000 for single taxpayers ($230,000 for married filing jointly),you can contribute a maximum of $7,000 under the age of 50. If something disastrous were to happen, you can withdraw only the amount of your contributions made within the current tax year—including any earnings on those contributions—then the contribution is reversed. For example, if you contribute $7,000 in the current year and those funds generate $500 in earnings, you could withdraw the $7,000 principal tax- and penalty-free, and the $500 gain becomes taxable income. You would have until the tax-filing date for the year to return the funds to your account and have them applied.
In events of prolonged unemployment or a serious illness, for some, withdrawing Roth contributions after you have depleted your emergency fund might be a better option than racking up interest charges on credit card balances. Furthermore, if you are in a situation where you know you may need to use Roth IRA funds as a last resort, consider having some funds within your Roth available in cash. You do not want these funds in stocks or mutual funds subject to market conditions. Once your situation stabilizes, start moving those cash funds into higher-earning investments.
If you have questions on how to establish an emergency fund while saving for retirement, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the June 22, 2024 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
