Using your Roth as part of your emergency fund--good idea?

[CompoundInterestFan]

I've come across this idea before (I think from a poster on this board), and at first it sounded suspect, but after thinking about it I kinda like it. I already have about 3-4 months worth of expenses in my emergency fund (money market), but savings are tight right now, so it will take a while (at least a few more years) to get it to 6 months. During that time, if I'm dumping anything extra into the EF, nothing's getting put in the Roth, and I'm missing out on compounding. So, why not kill two birds with one stone? If I'm not mistaken, you can withdraw the principal from your Roth tax-free (since you've already paid taxes on it) and penalty-free (since it's only the principal). I know it's not ideal, but it will allow me to be contributing to my Roth rather than waiting until I have the full 6 months EF. Then, when savings aren't as tight as they are now, I'll start putting more into the EF.

What do you think?

[Deetso]

I almost posted something similar in the "do you count your emergency fund in you AA" post. I do this now and so far it seems to be working- but only because I havent had any emergencies to deal with. I started doing it when two years ago I wasnt going to be able to fill my Roth by tax day. I decided to take it out of savings. Then a year ago I filled my Roth early, with my emergency fund, instead of saving it up until the last minute. That seems to be giving me time to fill up my savings again- but I think I might just be filling up my Roth on 1/1/08 mostly out of my emergency fund again next year...

Im interested to see the responses to the OP.

[SecondCor521]

One drawback to consider is that if you do have an emergency and do withdraw principal from the Roth, the funds you withdraw cannot be replaced, and all future tax-free compounding of those funds within the Roth will have been lost forever.

2Cor521

[CompoundInterestFan]

Originally Posted by SecondCor521

One drawback to consider is that if you do have an emergency and do withdraw principal from the Roth, the funds you withdraw cannot be replaced, and all future tax-free compounding of those funds within the Roth will have been lost forever.

True, true. That's the risky part. Keep in mind I'm thinking of this as a temporary solution until I'm able to contribute more to the EF without starving the Roth.

[Coach]

CompoundInterestFan, I think your plan makes sense. As an interim step, until you get to the point where you can fund your emergency fund in addition to your Roth.

There are some small downsides, but none that seem anywhere near as bad as giving up the opportunity to fund a Roth.

Coach

[Nords]

Originally Posted by SecondCor521

One drawback to consider is that if you do have an emergency and do withdraw principal from the Roth, the funds you withdraw cannot be replaced, and all future tax-free compounding of those funds within the Roth will have been lost forever.

I think this is the criterion that'll help distinguish between a true emergency and a mere temporary inconvenience.

Under that circumstance it beats the heck outta using credit cards or a HELOC.

[Silhan]

Originally Posted by SecondCor521

One drawback to consider is that if you do have an emergency and do withdraw principal from the Roth, the funds you withdraw cannot be replaced, and all future tax-free compounding of those funds within the Roth will have been lost forever.

2Cor521

Yes, but the resulting Roth balance would not be any less than if the money had been put into the non-Roth emergency fund to begin with.

[Celany]

Originally Posted by Nords

Under that circumstance it beats the heck outta using credit cards

I dunno about that. to me, it would depend on the interest rate of the CCs, plus, the knowledge that, once that Roth money is gone, it's gone. I think I'd rather charge something on a CC, even @ an 18% interest, as long as I had a reasonable expectation to pay it back within, say, a year, than suck the money out of my Roth & have it be foverer gone.

I personally would never use my Roth as an EF. Somebody correct me if I'm wrong, but my current understanding is that if someone declares bankruptcy, the Roth would be protected, whereas CC debt could be gotten rid of, or reduced. I am not at all for bankruptcy, but if I had, say, crushing medical debts, I'd rather put them on the CC, & then have the chance to renegociate payments w/the hospital/collections agency, than raid my Roth to pay it off & have so much less money for tomorrow.

[Nords]

Originally Posted by Celany

I dunno about that. to me, it would depend on the interest rate of the CCs, plus, the knowledge that, once that Roth money is gone, it's gone.

My point is that it's all too easy to whip out the plastic or a checkbook to handle an "emergency" that's really just a temporary crisis. ("You call that 'resort attire'?!? You better believe this is an emergency-- a fashion emergency!!") The money's just too accessible.

Having to sit down at a computer to vampire a Roth, or having to fill out the paperwork for the distribution request, will cause people to re-evaluate just what sort of emergency they think they're facing. It might not seem like such a crisis after all, and that's one benefit of using a harder-to-tap asset for an emergency fund.

[Celany]

Originally Posted by Nords

My point is that it's all too easy to whip out the plastic or a checkbook to handle an "emergency" that's really just a temporary crisis. ("You call that 'resort attire'?!? You better believe this is an emergency-- a fashion emergency!!") The money's just too accessible.

aha, I getcha now.

you know, I used to be that kind of person ('fashion emergency!!!'), but I'm so disciplined nowadays...an emergency is a major health issue, or...well, I think that's pretty much it. I pay all my bills on time, so I don't need to worry about the heat getting turned off, or anything like that.

I did recently shell out some extra $, because I started looking at my job options, & needed a new portfolio (not cheap - $130) & a few new pieces of clothing. But I wouldn't call that an emergency - it just means that I'll cut back on my spending for the rest of the month.

[crazy connie]

I think that considering ROTH contributions as PART of the emergency fund is fine IF:
1. You have stable employment and are routinely comfortable with LBYM
2. You have a couple of months in basic cash account to cover basic emergencies i.e. a new heat pump, appliance dies, unanticipated major car repairs, flights for family emergency, death of grandparent etc...

I would let go of a lot of stuff or things before dipping into a ROTH but if you have a good employer and do not see a problem on the horizon then it makes sense to me.

The reasoning to me is if you do this... over time your ROTH grows but your cash stash also grows and in a few years the emergency fund is up to where it should be!

[Animorph]

I think you need to have the "emergency cash" in the Roth as very short bonds or money market. You don't want to buy a stock fund in the Roth, have it lose money, and then need to withdraw your initial investment. It might not even be there.

Still, not a bad idea.

Dan

[CompoundInterestFan]

Originally Posted by Nords

"You call that 'resort attire'?!? You better believe this is an emergency-- a fashion emergency!!"

Thanks everyone for your responses. Just wanted to make sure I wasn't overlooking some big disadvantage or gotcha.

[theoldwizard]

Originally Posted by CompoundInterestFan

... If I'm not mistaken, you can withdraw the principal from your Roth tax-free (since you've already paid taxes on it) and penalty-free (since it's only the principal). I know it's not ideal, but it will allow me to be contributing to my Roth rather than waiting until I have the full 6 months EF. Then, when savings aren't as tight as they are now, I'll start putting more into the EF.

I think a lot depends on your age !

If your over 59.5, then you don't need an EF at all, because you can just take it from the Roth directly.

Under 59.5, then your strategy sounds feasible, but a lot depends on how disciplined you are ! Some would say, with you logic, you would never fund an EF. That might not be too bad if you really are religiously maxing out your Roth.

A couple of other thing, I think an EF should be more like 12 months and after all reasonable insurances include life (if you have dependents) and long term care.

[old woman]

I keep in mind I could tap my ROTH if I had to, I could also tap my HELOC. I don't even have an emergency fund. I never have emergencies. I have a 2-3K in checking most of it at 4.25% but I plan to use that maybe to pay for this year's ROTH.
I can handle little things like a broken appliance or car repair put it on Discover and pay for it in about 45 days without interest, to me that isn't an emergency it just is spending.
I can live on unemployment if I have to or sell some taxable investments or ROTH and if I lose my job I am 59 so being over 55 I could draw on my 401K.