Contributing to a tax-advantaged retirement account comes with rules that can make it difficult to get your hands on your cash should you suddenly need it. These controls are one reason people can feel understandably reluctant to fund an IRA or 401(k) to the max each year, even though they know the earlier they invest, the greater the advantage their funds will have to grow at tax-free compounded rates. The desire to save for retirement gets trumped by the need to maintain an emergency fund of easily accessible money, be it for car repairs, medical bills or a job loss.

Happily, an often-overlooked feature of the Roth IRA could solve this problem—allowing you to have your cake of liquid funds and invest it too.

key takeaways

  • Because you can withdraw contributed sums at any time sans taxes or penalties, a Roth IRA can double as an emergency savings account.
  • Roth funds should only be withdrawn as a last resort.
  • When withdrawing funds, be sure to limit the sum to your contributions; don't dip into earnings, or you will be penalized.
  • You can redeposit withdrawals from a Roth, preferably within 60 days—or at the latest, before the tax filing deadline for that year.
  • No matter how much you withdraw, you can only redeposit a sum up to the current Roth IRA contribution limit for the year.

Quick Recap: Roth IRA Rules

There are limitations on how much you can earn to qualify for a Roth. The IRS begins to reduce the size of your contribution if your filing status is married filing jointly or qualifying widow(er) and your modified adjusted gross income (AGI) is $193,000 to $203,000 in 2019; if your modified AGI is $203,000 or more you can’t contribute at all. Single filers and heads of household hit the reduced contribution threshold at $122,000 and are disqualified once their income exceeds $137,000.

But If you do qualify, a Roth allows you to save as much as $6,000 per year in 2019. If you’re married, you and your spouse can each contribute $6,000, for a
total of $12,000 (or $11,000 in 2018). Add an additional $1,000 per person to both 2018 and 2019 contributions if either or both of you are age 50 or older.

Unlike contributions to traditional IRAs, Roth IRA deposits don't generate a tax deduction when you make them; in IRS lingo, they're done with after-tax dollars. The money in the account grows tax-free until retirement. And when you do retire, you pay no taxes on withdrawals—because you effectively did that when you made the deposits. You also won't be mandated to take required minimum distributions (RMDs) from that account; the money can continue to grow tax-free until you need
it. (With a traditional IRA, you do pay taxes on withdrawals and taking
out a certain amount after age 70½ is required.)

You have 15½ months each tax year to accumulate emergency funds to place in a Roth. For example, for the tax year 2019, you can make contributions from Jan. 1, 2019 through April 15, 2020.

Now for the good part. Because contributions to a Roth are made with funds on which you've already paid taxes, IRS rules allow you to withdraw that money—the sum of your contributions, in other words—at any time without penalty or taxes. Only any investment earnings generated by your deposits—interest income, dividends, capital gains—must remain in the account until you’re 59½ in order to avoid paying a 10% penalty.

“Roth IRAs remain the most flexible retirement accounts in the country,” says Jeff S. Vollmer, managing director of Hyde Park Wealth Management in Cincinnati. And, one might add, the most flexible. So, in effect, your Roth account can double as an emergency savings account. It can give you the safety of knowing that, if you really need it, you have penalty-free access to a key part of these savings.

The Roth IRA as Emergency Fund

The advantage of putting emergency savings into a Roth IRA is that you don't miss the limited opportunity to make that year's retirement contribution. You can only contribute a few thousand dollars to a Roth IRA each year, and once a year passes without a contribution, you lose the opportunity to make it forever. You shouldn't miss out on making a year's contribution—it’s an opportunity (and future tax break) you’ll never get back.

Accessing these funds, however, should be your last resort. Matt Becker, a fee-only certified financial planner who runs the site momanddadmoney.com, points out that you don’t want to be withdrawing Roth IRA contributions for minor emergencies such as car repairs or small medical bills; you should keep enough in savings for these events. Your Roth IRA emergency fund should be for larger emergencies such as unemployment or a serious illness.

Withdrawing Roth contributions is also a better option than racking up interest charges on outstanding credit card balances. Provided, that is, that doing so will clear your accounts once and for all, and you'll never get that deep in debt again. Promise?

Structuring the Roth IRA for Emergencies

The key to using a Roth IRA as an emergency fund is to limit distributions to contributions; don't start dipping into investment earnings. Admittedly, IRA funds aren't labeled "contributions" and "earnings" on your statement. Still, following this rule is simple: Don’t withdraw more than you’ve put in.

"It is critical not to invest the portion of your Roth dedicated to your emergency fund,” says Garrett M. Prom, founder of Prominent Financial Planning in Austin, Texas. “This money is for emergencies, which in most cases is job loss. If that job loss is part of a downturn in the economy, you will have to sell investments, usually at a loss.”

The part of your Roth IRA contribution earmarked as your emergency fund doesn’t belong in stocks, bonds or mutual funds like a typical retirement contribution. It belongs in a liquid account which still earns a bit of interest, but one from which you can withdraw at a moment’s notice without losing principal. Ally Bank, for example, has an IRA savings account that pays 1.85% interest, as of September 2018.

Gains to the Roth account will increase without having to pay taxes on the earnings every year, as would be the case with a regular savings account. You also won’t have to pay tax on these earnings when you withdraw them as qualified distributions once you reach retirement age.

While the IRS calls early emergency withdrawals “unqualified,” which makes it sound like you’re breaking a rule, “qualified” distributions are simply those that have been in your Roth for at least five years and that you withdraw after age 59½.

A savings account within a Roth can earn at least as much interest as a regular savings account—if not more, depending on where you bank. If you already have a Roth IRA but your brokerage doesn't have any low-risk places to keep your money while still earning interest, open a second Roth IRA at an institution that does.

Once you have a large enough emergency fund, start moving those contributions into higher-earning investments; you don't want all of your Roth contributions in cash forever. This process might take you a few months or a few years, depending on how quickly you can accumulate additional savings.

Withdrawing Rolled-Over Roth Funds

If your Roth IRA contains contributions that you converted or rolled over from another retirement account, such as a 401(k) from a former employer, you’ll need to be careful about any withdrawals, because there are special rules about withdrawing rollover contributions. Unless they've been in your Roth for at least five years, you'll incur a 10% penalty if you withdraw them, and each conversion or rollover has a separate five-year waiting period.

Withdrawing rollover contributions penalty-free can be tricky, so it’s a good idea to consult a tax professional if you find yourself in this situation. The good news is that if you have both regular contributions and rollover contributions, the IRS first categorizes your withdrawals as withdrawals of regular contributions before it categorizes them as withdrawals of rollover contributions.

How to Withdraw Roth Funds

Funds availability may differ depending on the institution where you keep your Roth and the type of account you place the money in. When you need money urgently, you don't want to hear that it will take days to get a check or bank transfer, so find out before making a contribution to your Roth IRA how long distributions actually take.

Funds can typically be retrieved in less than three business days. If you are taking funds out of a money market or mutual fund and you put in your withdrawal request before 4 p.m. EST, you will have the money by the next business day. If the money is invested in stocks, you will need to wait three business days typically, although if you have a checking account with the same institution where you have your Roth IRA, you may be able to get it faster.

A wire transfer can also be a fast way to access funds, though you’ll have to pay a fee that’s typically $25 to $30. “Most brokerage firms can wire funds directly from a Roth IRA to a checking or savings account in one business day, assuming stocks or bonds don't have to be sold to generate cash,” says Accredited Asset Management Specialist Marcus Dickerson of Beaumont, Texas.

These potential delays in Roth IRA fund availability are another reason to keep some emergency cash outside of your Roth IRA, in your checking or savings account, for extremely urgent needs.

Fill Out the Correct Tax Forms

You don’t need to report Roth IRA contributions on your tax return since they don't affect your taxable income. However, if you do need to withdraw contributions from your Roth IRA to use in an emergency, there’s paperwork involved. Even though you're allowed, you still have to report your withdrawals to the IRS on part III of form 8606.

If you use tax preparation software, it will ask you if you made any withdrawals from a retirement account during the year and guide you through the paperwork. If you use a professional tax preparer, make sure to tell him or her about your withdrawal so he or she can fill out IRS form 8606 for you.

If you only put money in your Roth and don’t take anything out, you have nothing extra to do at tax time. Also, if you make your Roth contribution before the income tax filing deadline for the year and need to withdraw that money before the filing deadline, the IRS treats these contributions as if you had never made them. You won’t need to report them at tax time.

Can You Return Withdrawn Funds?

If you do have to withdraw contributions, you can pay yourself back and retain your Roth contribution for that year if you act fast.

“If the emergency turns out to be a short-term cash flow issue that gets resolved quickly, [you] can put the money back into the Roth IRA within 60 days to refund this account,” says certified financial planner Scott W. O'Brien, director of wealth management for WorthPointe Wealth Management in Austin, Texas. Do that and the most you'll lose is a little bit of interest. You probably won't even have to report the withdrawal.

However, if you really need to, you can extend the deadline a bit. If you withdraw contributions made during the current tax year you have until the end of that tax deadline (April of the following year) to redeposit the money back in your Roth IRA.

If you withdraw contributions made in other years you can redeposit up to your contribution limit by the end of the tax deadline.

If you withdraw more than you can contribute in a year, you cannot re-contribute 100% of those funds during the same year. You can only put back your contribution limit every year.

Redeposited Roth Funds Scenarios

Let’s look at some examples for clarity.

Example 1

You’ve got $30,000 in a Roth IRA. You’ve contributed $20,000 in prior tax years and $5,500 this year, 2019. The remaining $4,500 has come from investment growth (earnings). If you withdraw $5,500 worth of contributions from this year, you have until April 2020 to re-contribute those funds back into the Roth IRA.

Essentially, by withdrawing your contributions from this year it is like your contribution never happened. Your Roth IRA contributions toward my limit are reset back to $0. If you go past April 15, 2020, and haven’t contributed $5,500 back into the Roth IRA then you won’t get to make a 2019 contribution at all.

Example 2

Same situation: $30,000 in the Roth, $20,000 from prior year contributions, $5,500 contributed this year, and $4,500 in growth. You withdraw $2,000 of contributions. You have until April 2020 to contribute another $2,000 or your Roth IRA contribution for 2019 will only be $3,500.

Example 3

Same situation, but this time you withdraw $10,000. That means you've taken out your $5,500 in contributions from this tax year, as well as $4,500 from the past. You cannot re-contribute the full $10,000 this year. You can only contribute up to your annual maximum of $6,000.

There is no way to put the entire $10,000 back into the Roth IRA other than contributing the remaining $4,000 to your Roth IRA in the next tax year, plus $1,500 more to bring it up to $5,500. (But then, one hopes, you were already budgeting to invest another $5,500—but you wouldn’t be able to do that.) To effectively borrow from your Roth IRA, you would need to have already made a contribution earlier in the year, withdrawn that contribution and paid it back before tax time the following year. There is no formal “loan” program with a Roth IRA like there is with a 401(k) plan.

The Bottom Line

The more money set aside for retirement and the earlier saving is begun, the better. Once a particular year's deadline passes for contributing to a Roth IRA, you've lost a chance to contribute for that year forever. Since the Roth has a relatively low annual contribution limit, you don't want to miss out on making the full contribution for any year if you can help it.

"The Roth IRA is the perfect place to stow those ‘just in case’ funds while also taking advantage of the opportunity for tax-free growth, and tax-free income, in retirement,” Dickerson says. The Roth shouldn’t be your sole source of emergency funds, though. Best is to have a separate emergency fund account as well as the money allocated for emergencies in your Roth.

In reality, most people won't have to go back and withdraw money from their Roth, which means they'll have more saved for retirement. And in a worst-case scenario in which money does have to be withdrawn, it can be done without penalty.