Using a Roth IRA as an Emergency Fund

Know IRA withdrawal rules: Using Roth IRA for emergency money can incur a 10% penalty

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Using A Roth IRA as an Emergency Fund

Powerpoint slides on a superior retirement planning strategy called Roth IRA on Roids which allows for tax-free distributions, tax-free growth, guaranteed principal and guarateed death benefits.Many people do not look at a Roth IRA as a source for emergency money. In fact, most people who have an IRA of any type are using that account strictly for retirement savings. While this is the most common avenue, there are other ways to use that money in your account. It is possible to use a Roth IRA as your emergency fund if necessary. However, there may be penalties involved if you do not meet certain requirements and abide by the IRA withdrawal rules.

Using a Roth IRA as your emergency fund: When Is It Safe?

Ideally, if you are over the age of 59 1/2 and you have been contributing to your Roth IRA for more than five years; there is no reason why this account cannot be used as an emergency fund. In simple terms, a Roth IRA can be used as an emergency fund if you are over the age of 59 1/2 and you will not have to pay any IRA penalties or additional taxes. In this scenario, it is simply a matter of withdrawing from the account. When you have met the withdrawal requirements for your Roth IRA, there will be no penalties or taxes involved should you decide to remove the money. This is one of the wonderful benefits of a Roth IRA. As long as you meet the age requirements and you have had the account for five or more years, you can use a Roth IRA as your emergency fund or for any other reasons you wish. Most people try to avoid withdrawing from the account if possible because it depletes your retirement savings. Yet, in the time of a crisis or an emergency, the Roth IRA is a perfect source for tax-free money.

Thinking Twice about Using a Roth IRA as your emergency fund

Now that we have discussed the option of using a Roth IRA as your emergency fund if you are over 59 1/2, let's discuss what would happen if you were under that age. First and foremost, you will face IRA penalties if you plan to withdraw more than you have contributed. For example, if you contributed $3,000 this year to the account, you can withdraw that amount at any time and you will not be taxed or penalized for the withdrawal. However, if you are withdrawing more than that amount, you will then be taking out some of the earnings. This part of the withdrawal amount will be taxed. No matter what your situation is, if you are not 59 1/2 when you withdraw from the account, you will incur an early withdrawal penalty when withdrawing the earnings. This amount is 10% of the amount withdrawn. That could add up to some serious money, depending on what your financial needs are at the time. In this case, it may not be beneficial to use the IRA retirement account as an emergency fund. Regardless of what your current situation is, any withdrawal before 59 1/2 that consists of withdrawing earnings in the account will be considered an early withdrawal. If you have other available funds that do not have penalties attached, you may want to consider tapping into those resources before withdrawing from your Roth IRA account.

Exceptions to Penalties for Withdrawing from Your Roth IRA for emergency

As with most rules, there are exceptions. While you will typically incur the 10% penalty for early withdrawal, there are many situations where that penalty will not apply. If you are using the money in the Roth IRA for a down payment of $10,000 or less on your first home purchase or using the withdrawal for college tuition for you, your spouse, or a dependent, you will not be penalized for withdrawing the money. In addition, if you become disabled, or you use the money to pay medical expenses in excess of 7.5% of your adjust gross income, or if you become unemployed and use the money toward health care insurance premiums, or the owner of the account has passed away, there will be no penalty. All of these situations can be classified as emergencies, thus making it beneficial to use a Roth IRA as your emergency fund.

Finally, there is one other way to avoid that ugly 10% early-withdrawal penalty, regardless of how you spend the money. You can take a series of "substantially equal periodic payments," based on your life expectancy, for at least 5 years or at least until you are 59 1/2 years old – whichever is longer.

72(t) Distribution for Roth IRA Emergency

You can even split off part of your IRA and take distributions based on that one account, reducing the amount you can access each year, but protecting the remainder of your nest egg. This strategy is commonly known as a 72(t) distribution. It works best if you are in your fifties and can commit to steady distributions for 5 years or longer. Once you choose the payout stream you are stuck with it though and the penalty for deviating is fierce; you will pay the 10% penalty retroactively from your first withdrawal plus interest.

Since many people do in fact like to use a Roth IRA as an emergency fund, it is strongly recommended to make the maximum allowable contributions each year. This will allow you access to more money if you do need to withdraw your contributions for an emergency.

Rocco Beatrice, CPA, MST (Master of Science in Taxation), MBA (Master of Business Administration), BSBA (Management/Accounting), CWPP (Certified Wealth Preservation Planner), CMMB (Certified Mortgage Broker), CAPP (Certified Asset Protection Planner), Managing Director, Estate Street Partners, LLC. Mr. Beatrice is an asset protection, award-winning trust, estate planning and tax expert.

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