Is using a Roth IRA as your emergency fund a good idea or not?

Everyone recognizes (or should recognize) the need for a good emergency fund.  If you happen upon hard times or unforeseen expenses, you’ll be happy that you socked away the equivalent of several month’s income.  A solid emergency fund is so important that many financial advisers make it THE top priority for someone who’s trying to get his or her financial house in order.

Generally speaking, you want your emergency fund to have a few basic characteristics:

1.  Liquidity.  It isn’t much of an emergency fund if you can’t get to the money in case of emergency.  Thus, you need to have fast access to any funds set aside for crisis resolution.

2.  Stability.  You may have room for some high-risk/high-yield investing in your life, but your emergency fund isn’t the place.  It’s money set aside for serious situations and you generally don’t want to expose it to much risk.

3.  Sufficiency.  Remember, this is the money that would keep you afloat in a “worst case scenario”.  You need to have enough of it set aside to protect you if the going gets rough.

Many people have noticed that your contributions to a Roth IRA can be yanked out at any time and that there’s no negative tax implication to doing that.   That makes it appear to be a credible place to maintain your emergency fund.  But is it?  Let’s look…

The money you used to fund the Roth was taxed as income when you first received it, after all.  Although the IRS isn’t known for having a heart of gold, even it is unwilling to beat you up on that money twice.

Please note, that isn’t the same as pulling out your Roth IRA earnings.  If you start trying to access the gains you’ve made from your Roth IRA contributions to meet an emergency need, Uncle Sam won’t blink an eye over levying a tax on your gains.

So, contributing to a Roth IRA has long-term investment value.  You can also pull out your contributions, as necessary.  Sounds like a perfect emergency fund option, right?

Not exactly.  Although it is a credible alternative to other popular emergency fund accounts (high yield savings accounts come to mind), there are few factors to consider before putting your “worst case scenario” cash in a Roth.

First, there’s the issue of liquidity.  Before you even think about using the Roth for your emergency fund, find out exactly how long it will take you to go from requesting a withdrawl to having a check in your hands.  For some folks, that will be a matter of minutes.  Others may find that it could take several weeks.  Consider what the lag time would mean to you in terms of meeting emergency needs.  If the lag time associated with your account is significant, it could be a reason not to to start using a Roth IRA as your emergency fund.

Second, consider the nature of your Roth investments and whether you need or want to trade them.  If you’re being very conservative with your Roth (i.e. putting your contributions in money market accounts), the idea of pulling out part of your contributions in case of emergency may not seem like a horrible idea.  If, on the other hand, your Roth contains stock holdings and other more volatile investments, you might want to rethink the plan.  After all, do you really want to sell a stock that’s temporarily undervalued instead of eventually achieving gains on the investment?  That can happen when the Roth is your emergency fund.  You might need to drop assets for less than you’d like to meet that short term need–at the expense of tomorrow.

Overall, using a Roth IRA as your emergency fund isn’t a bad idea.  There are a few things to consider, though.  If those issues resonate with you, it may be better to build a separate emergency fund in an immediately-accessible, low risk account of some sort.