Is a Roth IRA a Great Place to House an Emergency Fund?

This next question is a classic, but I think many people have it when they first start to see the power of investing. It’s from Nicole. She asks, “Someone told me that I should put my emergency fund in a Roth IRA. Is this something that you would suggest?” No, I’m going to be straightforward because I know Brian’s going to give me caveats; he’s going to do the thing. Oh, don’t give caveats. Nicole, do you know what your emergency fund is for? Yep, it’s right there. It’s right there in the title. It’s for emergencies, for those things that you don’t know might happen, for the things that could shift your financial life, as Brian says, into the ditch. So you want that cash to be there and accessible, readily available for you. In our opinion, the best place to house an emergency fund is in a high-yield cash account, a high-yield savings account, where it is safe and secure with no risk of loss of principal, and it’s earning something for you so that you can tap into it. My concern is you’re going to say, “Oh man, the Roth IRA, I really want to do it. I really want to max it.” And Brian’s about to come in here and tell you how you should never miss the opportunity to max out the Roth, and there’s going to be this break glass thing, and it’s going to be awesome. I’m going to argue that when the you-know-what hits the you-know-what, you’re going to want to get to that cash. And if that money is in a Roth IRA and it’s invested in, like, a low-cost index fund, and all of a sudden when you need that cash is when the market just lost 20, 30, 40%, and it was in that index fund, and it did that, now what you thought you had, the emergency fund, is not actually what is there. So I am a proponent of leaving your emergency fund in emergency access vehicles like high-yield savings accounts. Agree? Disagree? Ready to fight? I actually agree, but I feel like cave no loophole is what I wrote down. I wrote down loophole; I even put stars next to it because there.

I’m so conflicted by this, and there’s a reason. I mean, when you go to look at our Financial Order of Operations, it is obviously true that steps one and four are emergency reserves. Highest deductible covered is step one; step four is emergency reserves, which is more likely 3 to six months of your income or expenses. Step five is where the Roth IRA comes in. But then I just know too much, but this actually, that’s why you always hear people say, “I know just enough to make me dangerous.” This is where this kind, I guess you could invoke that asterisk to read the fine print is that it is true that Roth IRAs do have a break glass provision, just like Bo said, is in the fact that you have the ability to pull your basis back out of them, tax-free, penalty-free. Tax-free, penalty-free. Five-year mark is the holding period on the five years; is that something like that? That’s the only thing. I know that because this is where, you know, getting a little longer in the tooth is every little thing has a caveat on it. But there is, assuming you’ve read all the provisions on when you can get access to Roth, you do run into the problem that Bo said is that what if the market, because we all know that bad things happen, when it rains, it pours, you know, these things all happen where you lose your job, the stock market loses 20%, your real estate investments go down to where you wouldn’t have access to that. This could all happen at the exact same time. So then we come into the other weird thing about this loophole that I’ve brought up is that if you’re going to do this and use the break glass because it was just so important to get the contribution in this year because you know that maybe you got a pay raise coming up in six months or a promotion next year that’s going to answer all of your financial needs too, so it’s so important to get your Roth money in this year because Easy Street is only a few weeks to a month, few months away. But you run into this weird thing is that you can’t invest that money because it still needs to be your emergency reserves. And you know what emergency reserve money has to be? It has to be cash; it has to be liquid, liquid. So now you’re going to have Roth money just sitting in cash; that’s odd. I mean, it’s weird, like having a Ferrari just parked in the garage; it’s just so. That’s what, Nicole, I will tell you. I’m kind of, and I feel like I’m dancing over here like a boxer because you would have to have such a unique structure like I just went through a few things. It’s like you’re in this weird clutch situation that you have tons of potential but not much cash, but yet you know that in a few years, you’re not even going to be able to make Roth contributions because your future’s so bright that you have to wear shades. It’s one of those things where that is such a unique thing, I think, for the lion’s share of people.

I am with Bo, is that there’s a reason emergency reserves is step one and four of the Financial Order of Operations, and you should focus on that. Don’t get cute where you hold off filling up the emergency reserves because you say you know you’re saving, you’re putting in your Roth IRA because more than likely you’re doing your Roth IRA into, like, S&P 500 indexes or an index Target Retirement fund or something like that, and you’re kind of in conflict through the entire process. Where it might be better is if you look at how much money you have coming in through income, how much you have coming out through expenses, and then figure out how do we get through steps one through four as efficiently as possible so then I can attack that Roth IRA the right way. Once I got that emergency fund in place, well, then I just turned on my monthly automatic contributions to my Roth, and now I’m off to the races, and I got that money building up. I got my emergency fund sitting over here. I think that’s an awesome, awesome place to be. That was not a binary answer; that was very clean, I felt like. So that’s going to be one. Go ahead, trolls. I gave you a real answer. No, look at that. But there’s going to be people coming out from underneath the bridge and be like, “He didn’t say anything.” I don’t understand when I give you all the variables. That is the answer because it depends upon your specific situation. This is why I know my job will be protected forever. Is that you can ask me questions, and I’m going to pull. I’m going through the Socratic method. I’m going to ask you the questions to find the answer for you specifically. But for a Q&A show with thousands upon thousands and millions of people that will see us in the future, it’s impossible to know what yours is. So I try to give you as many variables as I possibly can.