Introducing the Roth IRE

June 15, 2010 · 14 comments

Oh man. I might be going to personal finance hell for this one, but ya gotta at least hear me out. You’ve all heard of the Roth IRA right? You know, it’s a crazy awesome type of Individual Retirement Account. Well, today I would like to introduce you to a new concept. The Roth IRE. That’s right. An Individual Retirement Emergency fund.

If you’ve heard of the Roth before, you probably know the annual contribution limit is $5,000. You probably also know that Roth contributions are made with ‘after-tax’ money. What you may not know is this tasty little morsel: Anyone can withdraw their Roth IRA contributions at any time, without penalty. No, you can’t withdraw earnings, but the contributions are free game.

So here is what I’m thinking. I currently have $10,000 in my E-fund. Currently, that’s about 6 months of expenses. Once I get hitched, however, that $10K only becomes like 3 to 4 months of expenses. This means I am faced with two goals that will soon conflict one another. My goal to have 6 months in an E-fund vs. my goal to fully fund my Roth every year. Unfortunately, I can’t do both at the same time. Either the E-fund savings takes precedent, or the Roth contributions become priority.

This is why I have decided to intertwine the two goals.

I’m yet to contribute a single dollar to my Roth this year, as I’ve been aggressively paying down my student loans and saving for things like my wedding. This hasn’t left me with a ton of flexibility in my cash flow. What I plan to do is save $5,000 as quickly as possible. I’ll contribute to my Roth IRA in three increments (a $2,000 contribution and two $1,500 contributions…I’ll explain why I don’t dollar cost average in a future post). Since I will be diverting all of my discretionary income to my Roth, my E-fund will remain stagnant.

The chances of me actually needing access to my E-fund are slim at best. I have a very stable job, am in pretty good health (knock on wood), and don’t have a ton of expenses. Since I’m 96.3% sure I wont be using my E-fund any time soon, I’d rather contribute to my Roth and maximize it’s earning potential.

If, by some freak chance, I end up unemployed I’ll first use my $10K savings. If I am still jobless after three or four months of hunting, I can always tap in to my Roth. Yes, I know, using a retirement account as an E-fund is a personal finance sin, but if there is no tax penalties it’s not so dumb. Besides, it will only take me a few months (after I’ve contributed to my Roth) to build up my E-fund to a true six months worth of expenses, so the window for me to be “up a creek without a paddle” is very small.

What do you think about the plan? Would you contribute to your Roth or E-fund first? Anyone else out there do what I’m doing and use the Roth as a “short term” E-fund option? Any financial know-it-alls see any flaws in my game plan?

{ 14 comments }

1 Retirehappy

I am not a financial planner, so take what I say with a grain of salt, but I similarly first prioritize funding our Roth. We only have $6k in savings and $1200 a month in student loan payments, so we’re in an even scarier position than you in some ways, although the fact that we both have jobs that are guaranteed until the fall of 2011 eases our concerns a little bit. Our plan is to max our Roth IRAs this year, then fully fund our E-fund. Remember that you do have until April 2011 to fund your Roth for 2010, so that gives you a little extra time.

You don’t mention whether you intend to fully fund Girl Ninja’s Roth as well?

2 Larry

If you have a stable job, then 3-4 months of expenses in cash should be adequate. Your cash is earning next to nothing right now, while money invested in a Roth can be put into a higher earning mutual fund with tax-free growth. I certainly don’t think you need to assume 6 months in cash (I really hate the term “emergency fund”) is some kind of rigid goal. Some emergencies last six months, some three months, some a year or more; but surely that is a matter that every emergency can decide for itself.

3 Sandy L

We did a similar thing. Back when savings bonds were actually earning an okay interest, we decided to use that as our emergency fund. Fast forward a few years and now we have a year’s expenses worth of e-fund that we thankfully haven’t had to touch.

Since earnings from savings bonds may qualify for a tax deduction if used for college expenses, this pile of cash is now our e-fund/kid’s college fund. We still plan on funding the kid’s 529′s more heavily once we’re done with the mortgage, but like you said, there’s only enough cash for so many of my priorities, so something’s gotta give.

I also used some of my Roth IRA for a house down payment. You also get to withdraw penalty free if you’re a first time home buyer, I believe. I always saved 15% or more in my 401K, so I didn’t feel guilty draining my roth come house buying time.

Needless to say, I love the dual purpose idea.

4 Vic

I like the idea ninja. Retirement goals are good. However, an emergency fund is essential in this climate. I use my Roth IRA as part of my emergency fund while I’m still building my E-fund. You won’t need it and you can always use your e-fund money first. I don’t think this is a problem since it’s tax and penalty free on your contributions.

5 Donnie

I do the same thing, Ninja. Also, don’t forget that because of Girl Ninja, you guys can contribute $10k per year to the Roth IRA, soon.

6 Donnie

Are you going to open an awesome Savings account Roth IRA at ING Direct? That’s what I did. So easy to open and transfer money in.

7 Stephan

definitely contribute to the IRA. since you can access it in emergencies with no penalties except less retirement savings, you can use it just like an emergency fund. It doesnt even make sense to continue with the E-fund until you max out the IRA each year. If your luck runs out and you do lose your job, you will still have the money, it will just be in an IRA. either way, i think you are well prepared to face any sort of hurdle you may face.

Preferred Financial Services

8 paranoidasteroid

This is one of my favorite things about the Roth IRA. Yeah, you’re not supposed to dip into retirement savings, but what’s the difference between pulling money out in an emergency and not contributing at all? It’s smarter to take advantage of the contributions while you can make them. Also, the fact that the fund are in a “untouchable” account means you’ll be willing to stretch a little bit more or earn just a little more money before you dip into those funds.

9 Budgeting in the Fun Stuff

I’m with you on this one. A stable job means that the emergency fund is okay for now, so this sounds like a logical idea to me.

My husband and I can live off one of our incomes (not happily since I only make $35k a year, but it would be possible). Due to this, we are draining our emergency fund right now to pay off his car loan. We’ll use the rest of the year to pay ourselves back, but this will save us about $800 in interest…a 4.6% return is way better than the 2.1% we were getting with Smarty Pig. I don’t feel like it’s a huge risk since my job is stable and his is VERY stable (contracted school librarian position).

It’s all about risk analysis and yours seems low. :-)

10 Everyday Tips

Ninja, sounds like a plan to me. Thanks for sharing this info because I am sure many did not know all the details you explained about the Roth.

11 Aury (Thunderdrake)

Experts often say to keep your emergency funds in a liquid bank account. Usually in cash form. Though I don’t follow that plan; you would be doing something similar to what I do.

My investments and emergency funds are one and the same. If I end up with a need for emergency cash, I usually do something like sell my bullion, write options, or sell a portion of my shares.

12 StackingCash

Umm what happens if your Roth IRA lost money? You know me, the pessimistic lurker on your blog :) On the other hand, I’m a big fan of using available credit to buff up my emergency fund powers. How’s that for unconventional :P

13 PunchDebt

Ah that would be the downside. I am willing to take the risk seeing that the potential for me to need this money is small. It’s risky, but thought out :)

14 Larry

That’s why a bond component in your Roth might be a good idea. I use the Vanguard Balanced Index Fund for mine, which is a blend of their Total Stock Market Index (60%) and Total Bond Market Index (40%). It’s not FDIC-insured of course, but at worst I was down about 15% in early 2008.

Previous post:

Next post: