If the coronavirus pandemic has taught us anything, it is important to have money available at all times. That way, if you lose your job or run into an unplanned expense that your salary can’t handle, you can dive into your cash reserves and avoid borrowing. You can also avoid a scenario where you feel compelled to liquidate investments and lose on additional growth, or worse, conclude a permanent loss when the need for money arises.
As a general rule, it would be good to keep the cost of living for about three to six months hidden for emergencies. And you will often hear that you need to keep that money in a savings account.
But that is a problem. Given what savings accounts they pay with interest today, leaving so much cash in them could mean denying yourself much more generous returns. And if that doesn’t work for you, you might be thinking about finding another home for your emergency fund, like the Roth IRA.
But is that a smart move? Or should you limit yourself to just a savings account?
How Roth IRAs work
It’s the Roth IRA pension savings plan, and contributions are made in dollars after tax. Investment profits and withdrawals, however, are yours to enjoy tax-free pensions.
You will often hear that the Roth IRA makes sense if you expect your retirement tax rate to be higher than it is today. Also, Roth IRAs are the only savings plan that is not imposed in the tax required minimum distributions during retirement.
► Is the Roth IRA right for you? Ask yourself these 2 questions to find out
Can the Roth IRA be a good place for emergency savings?
When you fund a traditional retirement plan in preference (one that gives you a tax on actual contributions), you will be penalized if you remove money from it before you turn 59 1/2 years of age. But Roth IRAs work differently. Because the Roth IRA is funded in dollars after tax, you can withdraw your major contributions at any time without penalty (although if you touch your winnings, a penalty may apply).
Here’s what it means. Let’s say you’ve invested $ 50,000 in a Roth IRA over ten years, but your investment increases your balance to $ 60,000. You can remove your original $ 50,000 at any time and avoid being penalized, but if you tap part of your $ 10,000 winnings into your account, you could lose money.
There is a possibility that the Roth IRA will earn much better returns than you will get on a savings account, especially given today’s interest rates. And since there is no penalty for removing your major contributions early, you may want to consider placing your emergency fund in the Roth IRA.
But if you’re going to go that route, make sure you follow one key rule – have another retirement savings plan designed exclusively for your older years. Retirement savings are important because Social security generally they will not pay you a high enough fee to be able to live comfortably. If you fall into a pre-retirement retirement plan, you’ll take a risk when your older years fail, so you’ll need savings that you commit to not touching, even when emergencies arise.
It should be borne in mind that if you place your emergency fund in a Roth IRA, it may lose in value if your investments fall. Therefore, it is a safer bet to keep the principal to save that money. But if you really can’t stand the thought of losing on growth, then you can move forward with a Roth IRA, as long as you understand the risks.
It is always important to be prepared for a financial crisis, and a Roth IRA can be a reasonable place to store your savings. But don’t combine your emergency and retirement savings – it’s just not a wise move. Instead, make sure you save adequately for each purpose.
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