Over the years the option of using a Roth IRA as your emergency fund has come into fashion. Due to global economic uncertainty and ever-changing political landscapes, the certainty of paying your current income tax rate on contributions and then watching your investments grow tax-free has become more and more appealing.
Financial professionals have advocated the use of a Roth IRA as an emergency fund in the past, but it is not right for every situation. In some cases, withdrawing money from your Roth IRA can be costly, and should only be considered as a last resort.
A Roth IRA was originally intended as a way to save and invest for retirement. The flexibility of the Roth IRA has exposed these investment instruments to a wide array of possibilities that are not possible with traditional IRAs.
Every situation is unique, and you should always utilize the retirement investment services offered at full-service brokerages as well as discount brokerages such as ETrade, to better understand if this strategy is right for you.
Unique Features Make Using A Roth IRA As Your Emergency Fund Possible
Many of the rules that apply to a traditional IRA apply to a Roth IRA, such as limits on contributions, as well as age restrictions.
However, Roth IRAs enjoy their own rules that make them unique from other individual retirement accounts, with the main difference being the ability to make tax-free withdrawals of your original contributions at any time and for any reason.
This unique feature allows you to use this type of account for purposes other than retirement. A Roth IRA can be used to help purchase your first home, assist in paying unexpected medical expenses, as well as act as a safety net if you become unemployed .
You may also be able to withdrawal earnings tax and penalty-free if you meet certain requirements.
It is important to consider that although you may be able to withdraw $10,000 worth of contributions from your Roth IRA, when the emergency has ended you can not return that money to your account.
You would still only be allowed to contribute the maximum $5,000 (as of 2011) per year if you are under 50, and $6,000 (as of 2011) if you are over 50.
Pros And Cons Of Using A Roth IRA As Your Emergency Fund
If you have an emergency, a major advantage to having a Roth IRA is that you will not get hit with a tax bill if you find yourself in need of using a Roth IRA as your emergency fund.
Your Roth IRA will also allow you to invest in a variety of asset classes, and garner larger returns on your money than a traditional bank savings account or CD.
You will also be less liable to tap into your Roth IRA, as the funds are not as liquid as in a bank account. This also works against you, in that if you need the funds for an emergency you will have to sell your investments before being able to withdrawal the money.
There is also the added element of market risk, as you may be forced to sell your positions when the market is down and realize a loss on your investment. It may also take up to a week to receive your Roth IRA distributions, so a Roth IRA may not be the best fund for a true emergency.
It can also be risky to take away from your retirement fund, especially if this is your only source of retirement income. While it is possible to make using a Roth IRA as your emergency fund a reality, it may not be your best strategy.
Always consult with a trained financial adviser like the retirement specialists at ETrade, before withdrawing funds from your IRA, or using a Roth IRA as your emergency fund.
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