The Boring Newsletter, 4/27/2025

Hi Friendos,

Today is another installment of Everything Emergency Funds with a focus on whether it’s a good idea to use a Roth IRA as your emergency fund. Many otherwise high–quality sources tout the possibility of using a Roth IRA as a source for need-quick-cash, but I think this is a bad plan. If you need to tap into your Roth IRA, do what you need to do, but don’t make that your first-line plan for your emergency fund.

The reason people say you can use a Roth IRA as an emergency fund is because you are allowed to withdraw your contributions without penalty or tax consequences. But it’s not quite that simple, because if your contributions have grown in value since you first invested them, your account will be comprised of both contributions and investment earnings. Investment earnings can only be withdrawn tax-and-penalty free if (1) you are older than 59.5 and (2) if the account has been open for 5 years.  

Ok, so let’s say you feel confident in your understanding of these rules. The following scenario illustrates why it’s a still bad idea to use a Roth IRA as an emergency fund:

• You made a $4k contribution to your Roth IRA in 2022, $3k in 2023, and $5k in 2024, at the beginning of the year each year. Total contributions to date: $12k.
• In March 2024, you had a car accident. You were fine, thankfully, but the car repairs cost $4,000. You have to fork over the full amount of your $2,500 auto insurance deductible and a rental will run $800 for the couple weeks your car is in the shop because you had opted against rental coverage. You pull $3.2k from your Roth IRA to cover the charges you had put on a credit card. The IRS considers contributions to be the first dollars withdrawn, so your $3,200 withdrawal is all withdrawal of original contributions.
• The following week, you dog eats something while you’re out on a walk. You don’t know what it was, but the poor thing barfs some liquid and then doesn’t eat for a full day. After an x-ray ($600) and exam ($300), the vet declares that your dog needs surgery ($2800) to remove the object, otherwise the poor creature might die. What can you do but withdraw $3.7k from your Roth “emergency fund”?  Beware the Ides of March indeed.
• You’ve now withdrawn $6.9k of your $12k of original contributions.
• In late May, your landlord tells you they are selling the building and won’t renew your lease, so you’ll have to move at the end of July. For the next rental, you’ll need to come up with first and last month rent, plus a security deposit, plus out of pocket moving expenses. You expect to get your current $1.5k security deposit back pretty soon, but in the meantime, you have a cash flow shortage. You pull another $5.4k from your Roth “emergency fund.”
• Now you’ve withdrawn all of your original $12k of Roth contributions, plus a little bit of your investment earnings.

Does that scenario sound totally crazy? To me it sounds really unlucky, but totally plausible. Now this unlucky person will work to replenish their emergency fund after having to draw it down. They cut out some discretionary spending, stop 401k contributions at their job, and will set aside $1300 per month for the next 9-10 months. Oh, but in 2024 they can only contribute an additional $2k to a Roth account, so they’ll have to use another account starting in July to hold the remainder of replenishment savings for the rest of 2024. Now their emergency fund is spread over two different accounts. In Jan 2025 should they switch back to contributing to the Roth “emergency fund” or continue using the other account they established for this? They’ll have to decide. Hopefully they won’t accidentally overcontribute to the Roth and have to clean up that mess.

Other issues they’ll encounter:

• Recordkeeping for their Roth account, so they can show their tax preparer that nearly all their withdrawals were original contributions. Cost: 1.5 hours of time to run down documents and have a couple rounds of message exchange with the tax preparer.
• The tax preparer charges an $80 extra for filling out Form 5329 and Form 8606 for their tax return.
• Penalties and income taxes on the few hundred of early withdrawals from the Roth: $120.
• Extra mental burden from now dealing with two emergency fund accounts, figuring out which account to use when, and extra work to figure out the actual total in their emergency fund.

Don’t plan to use your Roth IRA as an emergency fund. Use retirement accounts for retirement saving and keep it simple! …and boring 🙂

-Stephanie