I have seen a number of personal finance websites suggesting that people keep their emergency funds in a Roth IRA. After all, the point of an emergency fund is to never have to touch it, saving for retirement is good, and one of the benefits of a Roth IRA is that you can take out the money you put in without any sort of penalty (of course, you can’t touch your earnings until you’re 59 1/2).
I’m still not sure whether or not I think this is a good idea. I have to admit that when I thought about starting a Roth IRA, one of the things I considered was the fact that if an emergency happens, I can pull that money. But I also have an emergency fund with enough money to cover almost 10 months worth of normal expenses.
I don’t think it’s a good idea to have all of your emergency fund in your Roth IRA. But it might not be a bad idea to put some of it into a Roth IRA. Let’s pretend that your monthly expenses are $3000. Now let’s say you’ve managed to save 6 months worth of expenses, meaning you’ve got a high yield savings account with $18,000. To fully fund your Roth IRA for 2008 would mean a deposit of $5000. That would leave you with $13,000, enough to cover you for over four months. And if things got bad, you could pull from your Roth IRA.
But wait. Roth IRAs aren’t like savings accounts. They aren’t even like stuffing the money under your mattress. They’re not guaranteed to make money over time. Mine lost $500 in the first six months. If I was depending on that money for my emergency fund, I’d be out of luck.
I think my opinion has to do with how big your emergency fund is. As I said, mine is nearly 10 months worth of normal expenses, much of which could be cut in an emergency situation. So yes, I would be fine with putting some of that into a Roth IRA. But do I think your entire emergency fund should be in your Roth? Absolutely not. If you want to make it work for you, tie it up in CDs. Sure, you’ll take a small hit if you have to redeem the CD early, but nothing like the hit you could take from a Roth loss.
Of course, Roths are designed to grow, so it’s possible you could deposit $5000 of your emergency fund into it and discover that your retirement fund has grown.
I think this is a decision that everyone has to make, but I still think that everyone should try to have three to six months worth of expenses in an emergency fund, preferably closer to six. Where you put it is up to you. Just be aware of all of the benefits and the risks.
Megan is a 40-something government employee in the Washington, DC area. She got interested in Personal Finance when she got out of college and realized that her paycheck wasn’t going to go as far as she had hoped. Since starting this blog, she has managed to buy a house and make a solid start on her retirement goals, and hopes to help others do the same. Here is her story:
In 2007, I was a gainfully employed 20-something with no debt but not a lot of knowledge about personal finance. It was a co-worker’s comment about Roth IRAs that sent me to the internet, searching for information. It was then that I realized that I really didn’t know a whole lot about personal finance and that my current financial situation was due a lot to inherent frugal tendencies, generous family members, a fear of debt, and good luck. While that was working for me, clearly I needed a better plan.
While I had no debt, I was also pretty much living paycheck to paycheck and not worrying about going over budget (I say this as if I had a real budget) because I had an emergency fund set aside to cover any overages.
Except that’s not what an emergency fund is for.
So I did a lot of research, read a lot of blogs, and decided that I needed a plan. I needed to budget. I needed to know what I was spending my money on. I needed to prepare for the future.
I decided to create a blog not only to make myself accountable to others but also to share the knowledge that I gained along the way. I’ve learned so much from my fellow bloggers, and I hope that my readers can find something useful in what I have to share as well.