Emergencies come out of nowhere. Your car breaks down, you get sick, your house floods after a natural disaster or you owe more on your taxes than you had anticipated. One thing is for sure: Life is full of expensive and unexpected emergencies that can give your bank account a workout.
You can withdraw any money that you contribute to the Roth IRA at any time without tax and penalty. That’s a big perk
Setting up an emergency fund with three to six months’ worth of expenses is one of the smartest money moves you can make. It’s common to set up a separate bank, or high-yield savings account, for your emergency fund. However, with the many benefits of a Roth IRA, it might just be the best combination of saving for retirement and emergencies all in one.
What is a Roth IRA
A Roth IRA is a type of retirement account where you can save up to $5500 in 2018 ($6,000 in 2019). A Roth works a little differently than a 401(k) or traditional IRA. The money you put in a Roth is post-tax (meaning you’ve already paid tax on the money you’re investing), while the withdrawals you take in retirement after 59 1/2 are generally tax-free.
A Roth IRA can be a great addition to your retirement savings. It’s possible that you’ll be in a higher tax bracket when you retire than you’re in now, making your contributions more valuable. With that said, a Roth IRA also comes with income restrictions that can limit your ability to contribute.
- If you’re single making over $135,000 in 2018 ($137,000 in 2019), you are phased out.
- If you’re married filing jointly and making over $199,000 ($203,000 in 2019), you are phased out.
How to Use a Roth for Retirement and Emergencies
There is a cool trick built into the functionality of a Roth IRA that makes it attractive for retirement and emergency savings. You can withdraw any money that you contribute to the Roth IRA at any time without tax and penalty. That’s a big perk. With that said, you can’t withdrawal any investment gains until 59 1/2 without incurring tax and penalties.
That means that your Roth IRA can serve two purposes:
- Retirement: You can invest in your Roth IRA to save for retirement just like you would in a 401(k) or traditional IRA and invest in all types of funds including index funds, lifestyle funds, stocks, bonds, etc. Once you retire, you can withdrawal money from your Roth to fund your retirement needs tax free.
- Emergency fund: You can withdrawal your own contributions at any point in time without tax or penalty. Therefore, you can use your contributions as a backup emergency fund when something unexpected and unplanned takes place. Of course, withdrawing money will lower your retirement savings, but you won’t incur penalties and tax like you would withdrawing money from other retirement accounts.
If your income is within the limitations, a Roth IRA can be a great addition to your existing retirement and emergency fund savings plan. It’s always best to save for retirement and resist touching those funds that you invested. However, knowing that you can access your contributions at any point in time should provide some relief from worrying when emergencies happen.