How to use a Roth IRA as an emergency fund
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Updated 10:31 a.m. UTC Nov. 7, 2023
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Key points
- Roth IRAs allow you to withdraw your contributions tax- and penalty-free.
- Experts recommend using Roth IRAs as emergency funds only in dire situations.
- Contact your financial advisor or brokerage if you must make a Roth IRA withdrawal.
A Roth IRA is an individual retirement account that lets you accumulate wealth tax-free. While there may be penalties if you withdraw earnings too early, you can withdraw up to the amount you’ve contributed without being subject to taxes or penalties.
This distinctive feature allows you to access your Roth IRA contributions anytime and for any reason, including in a financial emergency. It’s generally best to separate your retirement and emergency savings. But if the only alternative is financial ruin, your Roth IRA can be a lifesaver.
Before you start the withdrawal process, it’s important to understand how Roth IRAs work and the withdrawal rules. Consider the advantages and disadvantages of taking funds from your retirement account for immediate financial needs.
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What is a Roth IRA?
A Roth IRA is a retirement account that allows you to contribute after-tax dollars. While you can’t deduct your contributions from your income in the current tax year like you may be able to do with a traditional IRA, money invested in a Roth IRA grows tax-free.
Roth IRAs are specifically designed for low- and middle-income taxpayers. If your modified adjusted gross income is $161,000 or more as a single filer or $240,000 or more as a married joint filer, you can’t make Roth IRA contributions, at least not directly.
Roth IRA rules overview
Roth IRAs offer tax- and penalty-free withdrawals of contributions. But if you want to avoid taxes and penalties when withdrawing your earnings, you must follow certain rules. Otherwise, you may be subject to income tax plus a 10% penalty on the earnings portion of your withdrawal.
Here are the general guidelines to follow, along with some exceptions.
Age requirement
Because these accounts are intended for retirement savings, you generally must wait until age 59½ to withdraw Roth IRA earnings. Otherwise, you may be subject to income tax and a penalty.
Five-year rule
If you are 59½ or older and it has been at least five years since your first Roth IRA contribution, you can withdraw earnings tax- and penalty-free.
Note: The clock on the five-year holding period does not reset if you open a new Roth IRA. But if you convert funds from a traditional IRA, a 401(k) or another retirement account to a Roth IRA, each conversion has its own five-year requirement.
If you have reached the age of 59½ but haven’t met the five-year requirement, your withdrawal won’t incur a penalty but will be subject to income tax.
Exceptions
If you are younger than 59½ and haven’t satisfied the five-year rule, you can avoid the 10% penalty — but not income tax — in the following circumstances:
- You use the funds for a first-time home purchase (up to a $10,000 lifetime maximum).
- You use the funds to pay for qualified education expenses.
- You use the funds for qualified expenses related to a birth or adoption.
- You die or become disabled.
- You are unemployed and use the funds to pay for unreimbursed medical expenses or health insurance.
- The distribution is made in substantially equal periodic payments.
If you are younger than 59½ and have satisfied the five-year rule, you won’t have to pay income tax or a penalty in the following circumstances:
- You use the funds to pay for a first-time home purchase (the $10,000 lifetime maximum still applies).
- You die or become disabled.
Can I use my Roth IRA as an emergency fund?
Using your Roth IRA as an emergency fund is possible, especially if you don’t need to dip into your earnings.
But just because you can doesn’t necessarily mean you should. There are several factors to consider before you tap your retirement savings for your current financial needs. Even if the alternative is to borrow money, the long-term costs of a Roth IRA withdrawal could be more significant than potential interest charges.
“Considering a Roth IRA as an emergency fund can feel like a strategic move due to its flexibility,” says Taylor Kovar, a certified financial planner and CEO of Kovar Wealth Management. “It’s a tempting option, but caution is necessary.”
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Is a Roth IRA a good place for emergency savings?
Even if you have sufficient contributions to withdraw, it’s best to consider your situation and the potential downsides of dipping into your retirement account for emergency expenses.
Using your Roth IRA instead of a credit card or personal loan allows you to avoid costly interest charges. But while you may not incur an immediate cost when withdrawing Roth IRA contributions, each dollar you take out loses its compounding potential.
For example, let’s say you withdraw $5,000 from your Roth IRA for an urgent home repair. You withdraw only contributions, so you are not subject to income tax or a penalty. If you have 20 years until retirement, assuming an average annual return of 6%, you will miss out on roughly $11,035 in gains on that money.
In contrast, if you get a $5,000 personal loan with a 15% interest rate and a three-year repayment term, you will pay approximately $1,240 in interest.
“Using a Roth IRA as an emergency fund can be compared to utilizing a Swiss watch as a paperweight. It works, but it’s a costly sacrifice,” says Kovar.
And you may not be able to pay yourself back once you’re in a better place financially.
“There are annual contribution caps for Roth IRAs,” says Glen Hedrick, a financial advisor at Old North State Wealth Management. “After you withdraw that money, you can’t put it back in, which can make it harder for you to take advantage of tax-favored growth possibilities in the future.”
That said, if your financial situation is dire — maybe you’re behind on debt payments and can’t borrow more money or you’re facing eviction or foreclosure with no other place to live — tapping your Roth IRA could be worth considering.
How to use your Roth IRA as an emergency fund
Getting access to that money is relatively straightforward if you decide using your Roth IRA to cover emergency expenses is the right move.
Depending on where your money is held, you may be able to log in to your online account and request a transfer to your bank account. You can transfer only cash, though, so if all of your funds are invested, you’ll need to sell off some of your holdings. It may take a few days to settle the transaction.
If you go this route, you’ll be on your own to determine your contribution basis and how much you can withdraw without incurring a tax bill. You can do so by looking back at all your contributions to the account over the years and subtracting any previous distributions.
Alternatively, you can request a withdrawal from your financial advisor or brokerage firm. In this case, you can get a statement showing your contribution basis and earnings.
Regardless of how you request the withdrawal, transferring to your bank account may take a few business days.
Your broker will issue a tax form. And regardless of whether you have a tax liability, you must report the distribution to the IRS on your tax return.
Frequently asked questions (FAQs)
You can withdraw up to the amount you’ve contributed to your Roth IRA at any time tax and penalty-free. And you can generally withdraw Roth IRA earnings without penalty if you’ve reached age 59½ and your account has been open for at least five years.
But if you withdraw your earnings and don’t meet the age and holding period requirements, you may be subject to income tax, an early withdrawal penalty or both. There are some exceptions if you use the funds in certain circumstances.
To avoid income tax and a 10% penalty when withdrawing Roth IRA earnings, you must have had your Roth IRA account for at least five years. If you have multiple Roth IRAs, the five-year period starts when you open your first account.
If you do a Roth conversion from another retirement plan, however, each conversion has its own five-year requirement.
There’s no question of safety when using your Roth IRA as an emergency fund. But it can be costly to pull money from your retirement account to pay for immediate financial needs in the long run.
If you aren’t currently facing a financial emergency, make it a goal to build an emergency fund to avoid choosing between debt and lost retirement gains in the future.
“Aim to keep three to six months’ worth of spending in a liquid and accessible account, such as a money market fund or high-yield savings account,” Hedrick says.
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