Today our Emergency Fund sits in a regular savings account earning a less than impressive 0.20% interest rate. This is a temporary solution as I look at the best way to give us easy access to our funds if we need them. The original plan was to place our Emergency Fund into the highest yielding savings account that we could find, that’s currently around 1.50%.
But we’re accumulating a large Emergency Fund and these funds may sit untouched for years. So is letting the funds sit in an account earning less than the rate of inflation my best bet? Is there a better alternative?
One strategy I’ve been considering is using a Roth IRA to hold our Emergency Fund. There are several features of the Roth IRA that makes this appealing:
- You can withdraw all of your regular contributions at any time without penalty.
From Fairmark.com…
The rules for Roth IRAs permit you to do something that isn’t allowed for traditional IRAs: withdraw the nontaxable part of your money first. Distributions from traditional IRAs come partly from earnings and partly from contributions. But when you take money out of a Roth IRA, the first dollars you take out are considered to be a return of your regular contributions. You don’t have to meet any special tests to receive those dollars free of tax. You can take them out any time, for any reason, without paying tax or penalties.
- Earnings grow tax-free
- There are a wide variety of investment options including: money market accounts, mutual funds, bonds and treasuries and CDs.
- After 5 years you can withdraw up to $10,000 in earnings for a first-time home purchase (as defined by the IRS)
I still prefer to have funds easily accessible so I will probably keep 2 months living expenses in a high-interest savings account and put the remainder into a Roth IRA that can be accessed in an emergency – but hopefully we’ll never need to.
I would like to note that we contribute to retirement via a 401K so we are not impeding on our retirement. If someday we are able to max our 401K and contribute to the Roth, we’ll simply earmark the original funds as emergency funds.
I like this strategy because while I want to ensure we are prepared for any unplanned expense or loss of income, I also want to make sure our money is working for us without taking undue risk. I think the Roth IRA gives us that solution.
Hi, I’m Cathy! I’m a former career-driven professional turned stay-at-home mom. Living on one salary has its challenges, but it is possible to live the good life while spending less. Cool to be Frugal is all about how we’re thriving, not just surviving, on a single income.
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Hi! I applaud your efforts….but, a ROTH IRA is no place for your emergency funds. According to TRowe Price
Withdrawals have some restrictions,
“Tax-Free Contributions may be withdrawn at any time without taxes or penalties; earnings may be withdrawn tax-free and penalty free once you reach age 59½ and the account has been open for at least five years.
Taxable Earnings may be subject to taxes and penalties if distributed before age 59½ and before the account is five years old. ”
Don’t worry about the low interest rate environment now. Interest rates will likely rise sooner rather than later! You are better off with low rates now than paying a penalty and taxes withdrawing money early from a ROTH.
Hi Bab, thanks for your comment! Just to clarify, I am referring to “regular contributions” that are after-tax. Roth IRA rules state that:
1.) Distributions come from regular participant contributions until these are used up
~and~
2.) a distribution of regular contributions is always tax and penalty free, regardless of when the distribution occurs. There is no waiting period.
So, if I take $5,000 from my savings account and put it in a Roth IRA, I can withdraw that $5,000 at any time without penalty. It is when I try to withdraw earnings that I’ll face a penalty and taxes.
The point of the article is that I can take funds I have earmarked in a savings account as emergency funds and place them into a ROTH where they can potentially grow tax-free and still have the same access to those original funds (not the earnings) without penalty.
More information on this can be found at http://www.investopedia.com/articles/retirement/03/030403.asp.
Thanks for helping me clarify this as it is very important to understand.
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