A Roth IRA allows you to kill two birds with one stone by allowing you to put as much as $5500 from your emergency fund into your IRA ($6500 if you are 50 years of age or older). The money that you put in from your retirement account can then be withdrawn since you will have already paid taxes on the contribution. The rest of the untaxed money in the Roth IRA must be kept in the account until age 59 in order to avoid being penalized. Here are some important things to keep in mind when using your Roth IRA as a vehicle for emergency funds:
Know why you are putting emergency funds into your Roth IRA
A Roth IRA ultimately exists for your retirement and every year affords you the opportunity to invest more. You may never have to pull money out of your Roth IRA. If this is the case, you will have more money for retirement. Pulling money out of your Roth IRA for an emergency should be a last resort and should only be applied towards a major emergency. You should have an adequate amount of savings in other accounts for minor emergencies. However, pulling emergency money out of a Roth IRA is better than going into lots of credit card debt, and you will not be penalized for it.
Do not withdraw your earnings.
Withdraw only the contributions you have put in to the account. Do not withdraw your earnings or you will be penalized 10%. You can always put withdrawn contributions back into your IRA and maintain your annual contribution.
Do not invest emergency fund money.
You should be able to withdraw your emergency fund money without penalty or loss. So make sure that the money is not wrapped up in stocks or mutual funds. Keep your emergency funds liquid in an account that continues to accrue interest. So long as your account is growing, you will not have to pay taxes on it every year, nor will you have to pay taxes on them when they get withdrawn after retirement.
Having a savings account that is incorporated into a Roth IRA is just as good, if not better, than having a regular savings account. If your bank does not give you this option, then find a bank that does. You may also have more than one Roth IRA, so long as you do not exceed the yearly contribution limit.
Once your emergency fund is big enough, then you can start placing your contributions into investments that earn more. Do not keep your contributions in cash forever once you have acquired an adequate emergency fund.
Do not rollover funds that have been in your account under 5 years.
If you have rolled over money from another retirement account, you need to be aware of certain rules that apply to withdrawing those contributions. You incur a 10% penalty when you withdraw rollover funds that have been in your Roth IRA under five years. If you have both rollover contributions and regular contributions, the IRS will consider any withdrawals to be from your regular contributions first.
Know how long it will take you to access your contributions from the bank in the case of an emergency
The time it takes to access your emergency funds will differ according to the institution and what kind of account you have placed the funds into. Most savings can be acquired in less than three business days. The quickest way to access your emergency funds will usually be by having a checking account at the same institution that maintains your Roth IRA. Since some funds cannot be immediately accessed in the case of emergency, make sure that you have money in a savings account that can be.
Make the most of your contributions.
Always make the most out of your annual contribution since the annual limit is as low as it is. As of this year, you can contribute up to $5500, or $6500 if you are 50 years of age or older. Do not lose out on the chance to invest if you can help it. There are Roth IRA contribution limits for married tax filers, widowers, and single filers which may change from year to year. So be sure to consult a tax professional to figure out what your circumstances may mean for you. You may also make Roth contributions for a spouse who does not work or works for a low-wage. This is another way of making the most of your contributions that many people either forget or are simply unaware of.
Bottom Line
The Roth IRA is the best opportunity to store away emergency funds into an account that accrues interest and is tax-free. So during the 15-month tax year, take advantage of the opportunity by making any contribution you can.