Roth IRAs are some of the best tax-advantaged accounts that investors can access. Although you have to pay taxes on your Roth IRA contributions, the withdrawals are tax-free. That tax-free status extends to any capital gains and dividends.
A recent “CNBC: Your Money” video claimed that Roth IRAs can double as emergency savings accounts. The idea is that the money in a Roth IRA continues to grow tax-free, and you can then take money out of the account for emergencies.
However, there are some flaws within this assumption that are worth noting for people who want to abandon emergency savings accounts in favor of a Roth IRA.
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Every investment comes with risks and potential returns, and the mentality behind both of these accounts are different. People who put money into a Roth IRA want it to grow as much as possible. You don’t have to worry about any taxes on dividends or capital gains, so it’s the ideal place for growth stocks and ETFs.
However, people want more stability with their emergency savings accounts. For most people, a good emergency savings account is a bank account that yields 3%-4% APY.
While you can pull money from a Roth IRA during an emergency, it’s often a bad idea to sell stocks during market corrections. Viewing a Roth IRA as an emergency savings account makes you vulnerable to market timing. People who follow this strategy are essentially hoping that their Roth IRAs generate enough gains before they are needed for an emergency.
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You can withdraw money from a high-yield savings account at any time. Most banks limit you to six withdrawals per month before a small fee applies for additional withdrawals. However, most consumers can manage to stay below this threshold.
However, a Roth IRA’s funds aren’t accessible until you turn 59 1/2 years old. While you can technically withdraw from a Roth IRA at any time, withdrawing before you turn 59 1/2 years old will result in a 10% penalty. However, this 10% penalty only applies to earnings (i.e., dividends and capital gains), not your contributions. Young adults should avoid viewing a Roth IRA as an emergency savings account due to the penalty fee.
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