Does Your Emergency Fund Need Help?
2:44 Min Read
Personal finance experts tell us that ideally we should have 3-9 months' worth of expenses saved in an emergency fund. But in reality, 63% of Americans don't even have enough savings to cover a $500 emergency.1 So why do so few follow the experts' advice? Because for most of us, there is only so much money to go around. And when we are trying to save for more than one goal – such as building an emergency fund while saving for retirement – funding one goal can come at the expense of the other.
A Roth IRA may be the answer
If that scenario sounds familiar, you may want to consider using a Roth IRA to help you reach both savings goals. Contributions to a Roth IRA are made with after-tax money. The funds in your account are invested and grow tax-free, with no taxes assessed on qualified withdrawals after age 59 1/2. This makes a Roth IRA a great way to provide tax-free income for retirement.
However, a Roth IRA is different than traditional retirement plans because your contributions don't have to remain in the plan. You can withdraw them at any time, and for any reason, without penalty. Knowing that your money can be available to you whenever you need it makes a Roth IRA a great tool for supplementing your emergency fund.
A backup fund for BIG emergencies
But wait… isn't it BAD to withdraw money from your retirement accounts early? Well, yes. But not as bad as not saving for retirement in the first place. And not having to choose between building a six-month emergency fund or saving for retirement means that you don't miss the opportunity to make an annual contribution to your retirement account.
That said, you certainly don't want to make a habit of withdrawing money from your retirement account on a regular basis. You will still want to keep enough cash on hand to cover smaller expenses, such as an unexpected car repair. You should plan to access your Roth IRA funds for the really big things, like a job loss.
With a small emergency fund on hand to handle the smaller expenses, you are less likely to tap into your account, leaving your money untouched to grow for retirement. The worst-case scenario is that you have to take money out for a major emergency, but at least you can do so without penalty.
Investing Your Emergency Fund Dollars
A Roth IRA is an invested account, meaning it could gain or lose value, and you want to feel confident that your money will be there when you need it. So it's wise to invest the part of your account that is acting as your emergency fund in low-risk investments rather than in stocks. Once your balance has grown enough to supplement your emergency fund, you can begin investing future contributions according to your long-term risk tolerance.
Accessing your money
Withdrawing money from your account is easy, but it's not as immediate as swiping your debit card or pulling out money from an ATM. You will have to submit a request to access your funds, and then wait a few days to receive the money.
Also bear in mind that the amount that can be withdrawn tax-free and penalty-free from a Roth IRA is limited to the total amount you have contributed to the account. It's your responsibility to keep track of exactly how much you contribute. If you withdraw more than you have contributed, you will be withdrawing the earnings on your contributions and will be required to pay taxes on them and will likely incur a 10% penalty as well. Likewise, if your account balance includes rollover contributions from a previous retirement account, withdrawing those rollover amounts will incur a 10% penalty unless they've been in your account for at least five years.
Lastly, any withdrawals from your account must be reported on IRS Form 8606 when you file your taxes.
1 McGrath, Maggie, Forbes.com, "63% of Americans Don't Have Enough Savings to Cover a $500 Emergency," 2016.
Categories: All, Emergency Savings
Tags: Emergency Fund, Investing, Savings