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Roth IRA can be a back-up emergency fund

Gail MarksJarvis

5:18 AM EDT, August 2, 2013

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If people have discovered anything about money during the last few years, it has to be that emergencies pop up without warning.

Jobs can fizzle and home payments need to be paid even when the paycheck doesn't roll in. Cars need new tires and brakes despite pay cuts. Fender benders and broken legs happen even when you are careful, and water heaters burst and refrigerators fail when you can least afford a new one.

So as people get their feet on the ground after some tough years, there is a realization that it makes sense to have an emergency fund for the unexpected. Yet, for many households, it's still tough to come up with any extra money, and people debate whether they should plop their scant savings into an emergency fund or a retirement fund.

Glenda Moehlenpah, a San Diego financial planner, has a solution for those who don't have a lot of money available and can't decide between saving for emergencies and saving for retirement: Use a Roth individual retirement account to kill two birds with one stone, because both an emergency fund and retirement savings are critical.

After all, if you haven't built up retirement money by the time you can't work any longer, retirement will be a giant emergency. So starting on retirement saving is important even in your 20s and 30s.

Moehlenpah suggests using a Roth IRA for an emergency fund because it is more versatile than most people think. And it trumps many other savings devices for turning small savings into a sweet retirement stash. The beauty of a Roth IRA is that after you put money into it, that money grows without being taxed while it is invested. And it is never taxed if you follow the rules. So it grows with more power than a savings account and it gives you money that's off limits to Uncle Sam after you retire.

You can remove whatever you want from a Roth IRA after you reach age 591/2, and whatever you spend will be yours free and clear. Whether you retire with $200,000 or $2million, every penny will be yours. That's not true of a 401(k), regular IRAs or savings accounts. All end up getting hit with tax bills during retirement, and savings accounts are taxed during savings years too.

But, you might wonder, how a Roth IRA makes sense for emergency savings in your 20s, 30s or 40s, when government rules require you to keep money in a Roth IRA until you are 591/2.

The key lies in a Roth rule that allows flexibility. At any point in your life you are allowed to remove the contributions you have put into the Roth IRA without owing any penalty. If one year you stash $500 in a Roth, and the next you add $2,000, you are entitled to remove the full $2,500 for emergencies. In fact, you can remove the full $2,500 for anything, not just emergencies. If you want to pay for a wedding or a trip or anything else you find enticing, your contributions are there for the taking at any time. You will owe no penalty and no tax on that money.

Just make sure to leave in the Roth anything your investments have earned. For example, if you have contributed $5,500 and your investments have earned $300, your Roth will contain $5,800. You must leave the $300 in the Roth while you withdraw your $5,500.

And you can remove even more if you need money for college for yourself, spouse or child.

Of course, I wouldn't suggest tapping your Roth IRA savings for some whim like a vacation, because you need to save money for retirement throughout your working years and starting with your first job. If you start that early in life and don't touch the money until retirement, you could invest just $25 a week in a Roth IRA and end up with close to $1 million in retirement. Yet, waiting until later in life to start saving puts you at risk of ending up in a full-blown emergency in retirement. To provide $20,000 a year in retirement living expenses, you will need to accumulate about $500,000 saved by age 67.

That's why Moehlenpah likes Roth IRAs for emergency savings. If you are lucky enough to avoid needing emergency money, you will be on your way toward saving money for retirement. You are allowed to invest as much as $5,500 in a Roth IRA this year or $6,500 if you are 50 or older.

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis