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The Complete Guide to Building an Emergency Fund

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posted by William Cowie on 30 March 2016

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Life is full of little bumps … like how our furnace went out at the onset of last season’s most severe cold snap. It’s bad enough that an emergency like that seems to happen at the most inopportune time, but what’s worse is the $6,000 bill that accompanies it. Where do you get $6,000 quickly when you need it? If you’ve set money aside for a rainy day — an emergency fund — you’ll be less likely to go into debt or to tap your retirement funds when the bill comes. But how do you build an emergency fund that will truly protect you and your family? Let’s start at the very beginning — how much to save:

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Emergency Fund Calculator: How Much Should You Save? We might all agree that the purpose of a well-funded emergency fund is to help you meet unexpected events without going into debt, but the question of how much to save is a topic of endless discussion … and virtually no agreement. Some say three months’ worth of expenses; Suze Orman, the personal finance expert, recommends 12 months. Here are three steps to find the right amount of emergency savings for you and your family: 1. Calculate Your Monthly ‘Nut’. Tally up your monthly non-negotiable expenses. You must pay your rent or mortgage, but you can easily cut back on takeout or cut cable if times get rough or someone loses a job. Know exactly what that number is and what you can pull back on and what’s fixed.

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2. Consider the Worst Case. OK, this is no fun for anyone, but in preparing for the worst, it helps to understand what the “worst” looks like. For many families, a major health catastrophe or unexpected job loss are the main drivers for a large emergency fund. Ask yourself: how long it would take to recover from one of these scenarios? Could you expect a new job in weeks or many months? Could another spouse step into the workforce easily? For dual-income couples: Could you live on oneincome for a while or would it be tight from Day One? How is your health insurance? What would you have to pay out of pocket in extreme cases? Do you have access to disability insurance above and beyond state safety-net programs? 3. Set a Savings Target. Now that you’ve covered the very worst case, start saving for it. The baseline should be at least three months’ worth of total household expenses.

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How to Build Up an Emergency Fund

One common barrier to creating an emergency fund is when money is already tight. But experts say that only makes it more critical that you have one. Those living paycheck-to-paycheck might not have access to large amounts of credit or capital in an extreme emergency. Here’s how you can save on even the tightest budget: 1. Start with anything, even if it’s $1 a day. 2. Eliminate unnecessary expenses and redirect that amount into your emergency fund. 3. Modify direct deposit. If you can save money before your paycheck even hits your bank, why not? See if you can divert some portion of your direct deposited pay right into savings. 4. Use a different bank. If you can easily shift savings into checking with a few taps on your phone, it’s far easier to spend it on non-emergency items. Consider keeping your emergency fund in a different bank than your everyday checking account. You will of course want to find a high-yield savings account. Online banks usually have the best rates — and don’t forget credit unions. 5. Automate. The fewer decisions about this money means fewer temptations to spend elsewhere. 6. Keep the change. If you bank has a program where they round up debit card purchases and automatically put the difference in savings, grab it. Obviously this only works if you use your debit card regularly. 7. Use credit card rewards. If you are a credit card user who puts everyday expenses on your card and then pays the balance off each month, find a cash rewards card and convert that to savings. If you only get the cash back in a statement credit, take the equivalent out in cash and put that in your savings. 8. Divert every raise and bonus into this fund. You were living fine before the raise, so you will live fine after (only with a greater sense of security.) Lifestyle “inflation” is the enemy of saving. 9. Keep up with inflation. Every year things get more expensive, including all those things you are saving for — a new roof, new boiler, etc. Make sure you increase your savings rate with the cost of living.

Using a Roth IRA as Your Emergency Fund

I once heard Suze Orman advocate using your Roth Individual Retirement Arrangement (Roth IRA) as your emergency fund in a public television fundraiser broadcast. Like many here at Get Rich Slowly, she is a big fan of emergency funds. However, the concept of using your Roth IRA as the primary vehicle for your emergency fund is something we have never addressed. There are a number of reasons why using your Roth IRA as a vehicle for your emergency fund is a bad idea: 1. Penalties. Think twice if you read a blog that glibly states that you don’t incur a penalty when you withdraw from your Roth IRA for an emergency. That’s wrong. It may sound true in theory that the actual contributions you withdraw are not penalized. However, you’re rarely able to pull that off in practice. Example: Let’s say you’ve contributed $40,000 to your Roth over the years, and it’s earned another $10,000, bringing the total in your IRA to $50,000. Now, let’s say your furnace went out and you want to withdraw $6,000. You say, “Hey, I’ve put in way more than that, so the $6,000 I’m taking out is only from my contributions — I don’t need to touch any of the earnings.” Not so fast. The IRS and tax people call the money you put in (your contributions) “basis.” In other words, you say that you’re only withdrawing basis for your emergency — but the IRS doesn’t see it that way. When you take out the $6,000, they look at your IRA at the time and say 20 percent of the total ($10,000) is earnings and 80 percent (the original $40,000) is basis. Whenever you make a withdrawal, they deem 80 percent of the withdrawal to be basis and the other 20 percent as earnings. You don’t get to determine what is basis and what is earnings; they do. And they will penalize you on the portion of your withdrawal they consider to be earnings. So while, in theory, it may be true that you won’t be penalized on your basis which you withdraw, it rarely works out that way in practice. The topic of penalties on early withdrawals is complex and you will definitely need to see a tax professional to know if using your Roth IRA as an emergency fund makes sense. As a rough guess, though, that won’t be true in more than about 10 percent of all cases. For the final word on the rules and intricacies of Roth IRA withdrawals, please consult the definitive IRS source. Don’t just accept it when bloggers make glib statements like “tax-free in /tax-free out.” 2. The time guillotine. You can only contribute $5,500 a year to all your IRAs combined (Roth and traditional). It’s $6,500 if you are 50 years of age or older. Once every year’s deadline passes, the guillotine comes down on that year’s contribution and you can never make it up afterward. As we pointed out in The extraordinary power of compound interest, the key to success when investing for your retirement is to start early, and so it is vital to contribute as much as you can as early as you can to get those contributions on the other side of the guillotine — and to keep it there so your money can keep compounding. When you make a withdrawal from your Roth IRA to fund an emergency, you have only 60 days to replenish it. After that, the guillotine comes down on that amount and you cannot put it back. If you are able to replenish your Roth IRA withdrawal in less than 60 days, of course, this is not an issue. But if you can, why not simply use the replenishment for the emergency in the first place? 3. Economic cycle. Everyone knows that while most Roth IRA investments grow in the long run (like index funds do), they always fall victim to the downdrafts which the economy experiences every seven to 10 years. What if you needed access to your emergency fund at a time when your Roth IRA investments were at a low? You’d be forced to sell your investments at a loss. Some advocates of using your Roth IRA as an emergency fund counter that you should keep that part of your IRA in a money market fund to guard against a loss like that. But why? The return on those accounts is minuscule and you would be hard-pressed to discern a difference between tax-advantaged and not. You might as well keep that money in a regular account without any attempt to gain a tax advantage. Remember, you can only contribute $5,500 a year to your IRA. Why use part of that for something with no return? Far better to utilize that entire amount for investments which grow over the long term. 4. Psychology. One of the keys to success in investing for retirement is to forget about it. Put the money in before you consider spending it, in other words. Withdrawing money from your retirement fund is a slippery slope: Once you start, it becomes very hard to stop. 5. Liquidity. When an emergency strikes, you need to get access to your money fast. Few Roth IRA accounts will return your money within 24 hours — which isn’t helpful in an emergency, to say the least. It seems like it would be a better idea to find another vehicle for your emergency fund.

Where to Save Your Emergency Fund

The first attribute of a good emergency fund is liquidity — as in, you need to get at these funds within a few hours. The second attribute is safety, meaning it can’t be tied up in an asset that could fluctuate in the short run, causing it to be under water when you need to make that quick withdrawal. There are a few alternatives which pass the liquidity and safety tests: 1. Your mattress. It may not be politically correct to say this these days, but few options beat your mattress for liquidity. Another reason to keep at least a couple of hundred dollars in cash somewhere in your home? When a disaster strikes and power goes out, you may find that the stores and other places you could ordinarily process debit or credit cards — and/or your friendly ATM — may be out of power (or out of cash). This said, do not keep a large emergency fund at home. In order to keep pace with inflation (or at least try) it should be an interest-bearing savings account. 2. Savings account. In my opinion, the lowly savings account is by far the best place to store most of your emergency fund. The deposits held in an ordinary online savings account are protected against bank failure by the FDIC, and you can get quick access to your money whenever you need it. Most online savings accounts allow you to transfer the money to the account backing your debit or credit card, so you can usually pay for what you need within minutes. 3. Certificates of Deposit (CDs). A CD usually pays more than a savings account. Granted, you still need a microscope these days to tell if you earned any interest — but every little bit helps, as my wife likes to point out. For higher liquidity, no-penalty CDs are available, or you can create a CD ladder, which greatly increases liquidity. And, of course, CDs are protected by the FDIC too. 4. Prepaid credit or debit card. This is handy, especially for travel emergencies. If your first stop after an emergency is a hospital, you don’t have time to access savings accounts and things like that. Having a prepaid card handy will often take care of your immediate needs, giving you time to mobilize your second and third lines of defense.

Your best emergency fund strategy

The downside of the four suggestions above is they pay no interest, or close to nothing. When you look at the gamut of emergencies against which the fund is meant to protect, you find that, as the amounts increase, the probability you’ll need that entire amount decreases. For instance, if you lose your job, you’re not going to need all 12 months of your emergency fund right away. The longer you tie your money up, the more you get in terms of interest. That being the case, you might want to consider various layers of funds for your emergency fund money: 1. A few hundred dollars in cash for really quick access in case of a power emergency 2. A few hundred dollars on a prepaid card 3. A bigger chunk in an online savings account or no-penalty certificate of deposit. 4. A chunk in conventional CDs, laddered for staggered maturities. Which proportions should go into each account will depend on your situation and the emergencies for which you are preparing. In addition, take into account that interest rates are expected to rise in the coming years. Keep in mind that your Roth IRA will always remain in the background as a final if-it-comes-tothat source of money for seriously big emergencies. However, as regards using your Roth IRA to house the bulk of your emergency funds, the downsides seem to outweigh any pluses. Any consideration of the use of a tax-advantaged vehicle like a Roth IRA is likely to be more complex than you might think, especially because Congress keeps changing the rules. What you read two years ago is probably out of date in some respect. But regardless, if you must consider using your Roth IRA as an emergency fund, it’s best to consult a tax professional. The far better route is to use simple, easy-to-use and easy-to-understand financial products like an online savings account, a CD, or both. What are your thoughts? How are you saving for emergencies. Do you use your Roth IRA as an emergency fund?

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There are 58 reader responses to "The Complete Guide to Building an Emergency Fund".

Beth says 30 March 2016 at 04:41 I like the idea of layers :) People tease me about having an “emergency $20” in my wallet (I don’t carry much cash), but I also have some emergency cash around my home in addition to savings. I really think people need to look at what emergencies they might have and plan accordingly. For instance, as I look towards home ownership I’m building a larger emergency fund to deal with things like furnaces or appliances dying (things I don’t need to worry about as an apartment dweller). I also don’t live in an area prone to natural disasters like floods or tornadoes, but if I did, I’d plan for that too. One advisor told me to keep part of my emergency fund in my RRSP because if I lose my job and it was my source of income, then the tax implications are moot. For me, replacing a furnace or appliance isn’t an “emergency” — it would be part of a home maintenance fund I’m building. Reply

Kelly says 01 April 2016 at 11:01 I also don’t carry much cash. There have been a couple of times that an emergency $20 would have come in handy and I had to borrow. Once was for a taxi when my car wouldn’t start, and once was when the restaurant’s credit card system was down. Reply

Matt says 30 March 2016 at 04:45 Incorrect statement about Roth Ira withdrawals. Withdrawals from regular participant contributions are used up first according to ordering rules.Tax and penalty free no waiting period. More complicated subject for taxable and non taxable conversions and earnings before 59 1/2. See IRS publication 590B Reply

Larry Green says 30 March 2016 at 05:17 I always cringe a little bit when people recommend using a Roth IRA as an emergency fund for exactly this reason. Personally, I follow a layering strategy as well that I believe in. 1. $100 cash on hand 2. One months living expenses in checking 3. Five months living expenses in an online savings account Reply

Kelly says 01 April 2016 at 10:56 I agree with this. Just this week, having the checking account buffer became important when the bank screwed up our paycheck direct deposits on March 31st and I and other co-workers had mortgage payments scheduled to be taken out on April 1st. Because of their screw up, our deposits will not be in our accounts until Monday the 4th. So, that also means a full weekend without money that we were counting on. Reply

Kevin says 30 March 2016 at 05:23 Storing your emergency fund in layers is probably the best idea. Prepaid debit cards and cash in the mattress leave you very susceptible to theft or disaster. Certainly have some cash on hand if you need it in a pinch. As long as your fund is fairly liquid in a bank or investment, or can be quickly, I think that is good enough. My credit card has a 20k limit, and whatever I need to pay for I can charge to the card. Then put the funds into an account and pay off credit card. Note that I am not advocating using the credit card itself as the emergency fund, but rather the vehicle that closes the gap you would need to liquidize your emergency fund. Reply

Lindsay @ the Notorious D.E.B.T. says 30 March 2016 at 05:27 I had no idea about the basis/earnings calculation for Roth withdrawals. I’m glad I read this article before then; I might have made this mistake in the future. That’s pretty lame the government gets to decide what’s basis and what’s earnings. Oh well – we do have roads and police I guess. Reply

Adam says 30 March 2016 at 05:32 I don’t think that your information is correct regarding the taxes on withdrawal of contributions from a Roth. The Roth is a nice place for some emergency money (if you can’t max out the Roth for retirement), because you can take out contributions tax free. From IRS.gov (http://www.irs.gov/publications/p590b/ch02.html) The ordering rules for unqualified distributions are the following: 1) Regular contributions. 2) Conversion and rollover contributions, on a first-in, first-out basis (generally, total conversions and rollovers from the earliest year first). 3) Earnings on contributions. Reply

Michelle says 30 March 2016 at 07:02 I also agree with Adam. However, I’m not a tax professional. I wonder if someone who has actually done this could confirm. I think the article needs more clarification on this point. If what Cowie is asserting is actually true, this is a major big deal in the world of personal finance. If it’s false, he needs to edit his article. It would be irresponsible to leave this up. Reply

Xavier says 30 March 2016 at 08:53 I have withdrawn my original contributions from a Roth IRA before for the purchase of my first car. When tax time came around, I inputted the withdrawal information and had $0 in tax liability. Your withdrawal will be a non-qualified distribution and you should receive a 1099-R with a “Code J” most likely, but withdrawal of YOUR CONTRIBUTIONS are NOT taxable. TurboTax and any other tax software, accountants, etc. ask how much you have contributed to your Roth accounts so that it can reconcile that your withdrawal is not a taxable event. Reply

William says 30 March 2016 at 10:41 Could be true — it is best to talk with someone who really knows, though. But the post was more geared to the thought that there may be better places to save your emergency fund than the Roth IRA… Reply

Brent says 30 March 2016 at 10:35 If the author is correct there are articles on this site as well as just about every personal finance site that need updating! Just to give example to the majority belief vs what he is saying. 5.5K in, wait 5 years, new balance 6.5K, 5.5K out. Majority: No penalty or tax (1K balance remaining) Author: 1K gets added to your income this year and you pay a $100 penalty.(1K balance remaining but part is “contribution” still). Can someone get this fact checked by an tax accountant! Reply

David S says 30 March 2016 at 15:02 William got it wrong for Roth IRAs. Take note that the codified law states that you must take it in order with your contributions first, roll-overs next in a FIFO and earnings third. Here is the relevant U.S. Tax Code Title 26 Section 408A specifically under d.4.B (B) Ordering rules For purposes of applying this section and section 72 to any distribution from a Roth IRA, such distribution shall be treated as made— (i) from contributions to the extent that the amount of such distribution, when added to all previous distributions from the Roth IRA, does not exceed the aggregate contributions to the Roth IRA; and (ii) from such contributions in the following order: (I) Contributions other than qualified rollover contributions to which paragraph (3) applies. (II) Qualified rollover contributions to which paragraph (3) applies on a first-in, first-out basis. Any distribution allocated to a qualified rollover contribution under clause (ii) (II) shall be allocated first to the portion of such contribution required to be included in gross income. Reply

Jim @ Route To Retire says 30 March 2016 at 06:03 We’ve built up a pretty decent chunk of change that we keep in an online savings account since it pays a lot more than a regular bank. Although it’s still only 1%, I do like having the cushion there. We need to keep it a little more liquid since we also use it for down payments on rental property. I didn’t know about the basis and earnings when pulling contributions out of a Roth. That’s good information to know… better now than when you need it!! :-) — Jim Reply

Kevin says 30 March 2016 at 06:07 I would also suggest putting money in Treasury I-Bonds. They have lately been getting much better interest than savings accounts. There are two disadvantages. The first is a minimum hold time of one year. The second is that between years 1 and 5 you lose the last 3 months of interest. They aren’t as liquid as savings accounts but I think the slightly higher interest rates make up for it. Reply

William says 30 March 2016 at 10:38 Good thinking. Laddering a roster of those instruments might alleviate the liquidity somewhat… Reply

Steve says 01 April 2016 at 13:12 Ya. I do this. It takes a while. You have to ladder slowly because of the withdrawal rules. The advantage I see with this approach is that it allows you to build a conservative portfolio if you want. I follow Graham’s 50:50 rule on investments (outside of ROTH, 403B, and 529 options). So I currently have 12K in conservatively funded stocks and 12k in i-bonds. This grows by a couple of thousand in each account each year. Very slow. Boring. But I do think that one emergency people rarely think about is the upside advantages of having cash to hand should a bear market roll around. The twelve month efund seems like a good rule of thumb here, with notionally the idea that should a good buying opportunity come along, then 6 months could be used for a quick Vanguard purchase or the equivalent of full market funds. I know it is a conservative option, and others would say I’m sitting on gains/speculating, but 24K invested in this way does make some money. It provides me peace of mind by not being exciting. It grows. Not a lot. And I’m taking advantage of the other investment opportunities that are out there for someone in my income range. The i-bond rate right now is 1.65% for most six month increments. Reply

Elizabeth A says 30 March 2016 at 06:51 I have been looking into online high yield savings accounts and ran across IRA CDs which have a 2% interest rate when you choose a 60 month term. For me that would be the way to go if this doesn’t effect how much you can put in a ROTH IRA. However, I cannot find much real information about IRA CDs and if they are any different than a regular CD other than offering better rates. Does anyone know? Reply

Mark Nelson Jr says 30 March 2016 at 07:42 I think you’re mixing two different tax treatments with regard to how Roth distributions are taxed. The rules you listed aren’t the Roth distribution rules, they are the rules for withdrawing from a TRADITIONAL IRA with non-deductible basis. With a Roth IRA, distributions ALWAYS come from contributions first, then conversions, then earnings so there would not be tax or penalty in your scenario. Everything else I agree with though. Reply

William says 30 March 2016 at 10:37 I am not a tax expert — I interviewed a professional with more than 30 years’ experience, and those were his opinions. However… it still leaves the main point: there are better places to save your emergency fund than a Roth IRA. The layered approach (cash, prepaid card, savings & CD) offer more safety and more liquidity, and don’t expose you to the risk of the tax guillotine preventing replenishment or having to sell at a loss. (If you think about it, the likelihood of needing money often coincides with a recession… when the value of the Roth IRA might be at a low point.) And, of course, you will always still have the Roth IRA as the final layer, for when the emergency is that big and that bad. The point was just to mention that there might be a better place to save for your emergency fund than to blindly pile it all into your Roth IRA… Reply

Ginger says 01 April 2016 at 11:02 Except the reason for putting your EF in your Roth is if you DON’T have enough funds to save for both. If you only have $5500 to save per year, should you save part for retirement (in your Roth) and part for your EF (in a savings account etc like you recommend) or should you max out your Roth knowing that if there is an emergency you can pull from your Roth without a penalty as long as you have had the account for five years? The obvious answer, as Ms. Orman knows is to max out the Roth. Basically your entire has a flawed biased and you should read your own sources before publishing. Reply

Ginger says 07 April 2016 at 15:42 Correction to my last sentence, I had a typing error: “Basically your entire post has a flawed basis and you should read your own sources before publishing.” Reply

Drew says 30 March 2016 at 07:45 Great article, and the layer concept is what I landed on a few years ago. Some emergency cash “under my mattress,” some more cash in a savings account that I can transfer electronically to my checking instantly, and then the remaining big chunk of my 6-month emergency savings in an investment account in index funds. I dumped my CD ladder a few years ago when it became clear that interest income would be negligible, and because I haven’t had to dip into that portion of my emergency fund in 10 years, it’s really there just in case I am out of work for an extended period of time. Reply

Karthigan Srinivasan @ StretchADime says 30 March 2016 at 09:28 I wouldn’t recommend Roth IRA to be treated as an emergency fund. What if the market crashed and the money you put in is down 20%? Does it make sense to pull money out? There are other times when it might make sense to pull money out of a Roth IRA – The best place to keep your emergency funds is in a savings account – the old fashioned way. Investing in no penalty CDs and laddering them would be the best route to maximize the returns. Reply

B says 30 March 2016 at 09:45 What kind of emergency creates a need for the emergency fund within minutes – or even hours? I’ve never met a doctor or home or car repair person that needs to be paid within minutes or hours. A savings account that can transfer within a couple of days along with a credit card for smaller immediate expenses seems like it would always be sufficient. And what if the emergency is your house burning down? There goes your mattress money. Reply

Jeffrey Redfern says 30 March 2016 at 10:30 What about lines of credit? If what we’re talking about really is an emergency fund, then use a HELOC for instant liquidity, and quickly pay it off from less liquid sources. The interest you’ll pay will be trivial because you’ll rarely draw and you’ll pay it off quickly, but the returns from having most of your funds in other investments will be substantial. Reply

Kelly says 05 April 2016 at 11:12 I would assume the problem with a HELOC may be that if you loose a job or the value of your property goes down, you won’t have access to funds from a HELOC. Reply

cc says 30 March 2016 at 10:59 Orman is both right and wrong. If you have no other source of funds and have a true emergency, then by all means invade your Roth. You can figure out how to deal with comeback issues after the emergency. But planning your Roth as your emergency fund is poor planning. Your emergency fund should be liquid money within easy reach. Actually, it should be disposable income that you didn’t dispose of stupidly. I hate the term “emergency fund” anyway. I prefer to use the word ‘reserves’ because then I look at everything at my disposal should the need arise. Also, the real problem is that some people use the term emergency a little too loosely. Buying ANYTHING unneeded does not qualify, and beyond food, shelter and basic transportation (and medical as needed), not very much else qualifies. Just my opinion. Reply

Beth says 31 March 2016 at 03:28 I was wondering about that too. When I first read the article, I thought: “is a new furnace really an emergency, or something homeowners should budget for in a reserve fund?” I mean, you own a car, you hold money aside for car repairs. You own a house, you hold money aside for home repairs. If you can’t afford to do either of those things, how can you afford to pay back your emergency fund when you use if for just about every “emergency”? As I said in my comment below, putting emergency cash in a retirement account can make sense if you only touch it when you need income to live on, not to replace a furnace or something. I don’t use my RRSP for this purpose because once you take the money out, you lose the contribution room forever. With a TFSA, it’s after-tax dollars so there are no tax implications and you can replace the cash next year. I’m not American so I don’t know enough about Roth IRA, but if it’s like a TFSA then it’s just a type of registered account and you can hold a variety of different investments or savings within them. The real question is “do I use up my contribution room for my emergency account or not?” Reply

lmoot says 31 March 2016 at 04:11 That’s pretty much how I view my efund. I don’t have separate accounts for repairs because it’s hard to predict and I don’t like having multiple accounts. My motivation for saving an efund is predominantly job loss or inability to work (or desire not to work for a certain period of time). As for large expenses, I can usually put them on a cc and float it for 30-50 days. I pay as much as I can from checking and paychecks in that period, and if it’s not enough by the time the bill is due, I feed the balance from my “reserves/efund”. I also have the same savings for future goals (house, car, school, etc). I figure in an income loss situation I will raid anything at my disposal, from least to greatest in terms of cost to future savings, so having different buckets for me, is moot. I’ve also done the opposite and when a money-saving opportunity presents itself and I feel secure in my income sources, I’ll raid my efund for that as well. Really for me it’s what feels most important in the moment. Reply

cc says 01 April 2016 at 12:25 Separate accounts for every budget line item doesn’t make sense. Once you realize that (looks like you did) then you can take the next step and look at your household account just like corporations do: Multi-divisional nested inside one account number. I’ve seen people budget with envelopes, contribute to Christmas clubs etc. None of it made any sense to me – you had the same amount of money at the end regardless…. unless you were really stupid and put yourself into retail therapy, that is. For operational expenses, don’t go Hollywood. The simpler, the better. Just understand what is going to be spent out of it one way or the other and make sure there is enough in there to cover everything you think you’re going to have to pay … and then add at least 10% for the things you didn’t anticipate. And don’t forget to enjoy your money either. Saving it without treating yourself once in a while … whether it’s an ice cream cone, a new car or a short vacation, enjoy life. Money is just a tool to that end. Read Francisco’s speech from ‘Atlas Shrugged’ if you really want to know what money is. Reply

Linda Vergon says 30 March 2016 at 12:01 (This comment came from Michelle, a reader of our daily newsletter.) Longtime reader here. Love the wealth of personal finance information that GRS provides. However, I was shocked to read William Cowie’s article on Roth IRAs this morning. He makes a critical error in his explanation of withdrawing contributions from a Roth IRA. Several readers point this out in comments, but I still think the article needs to be corrected. Cowie- you should have done a little more research on this before presenting it as a central tenet of your argument. Reply

Noah says 30 March 2016 at 13:36 Emergency fund number 1: Cash in my wallet. 200 USD or foreign equivalent in emergency transportation money to get me home or to my hotel Emergency fund number 2: Credit cards (multiple, non-prepaid) and frequent flyer miles to cover home improvement and travel emergencies. Emergency fund number 3: My taxable investment account. Emergency fund number 4: Retirement investment accounts (401k & IRA). Do not use unless you are dying of cancer. Reply

Tonya says 02 April 2016 at 21:00 Do you have money somewhere to pay off #2? Reply

Noah @ Money Metagame says 30 March 2016 at 13:49 Just want to echo what some others have said regarding how you described Roth Distributions. Here’s some excerpts from the IRS doc you linked that explain pretty clearly that contributions are withdrawn first, they don’t average out the account for Roth IRAs as you specified: “If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA. … Order the distributions as follows. 1. Regular contributions. 2. Conversion and rollover contributions, on a first-in, first-out basis (generally, total conversions and rollovers from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion and rollover contributions into account as follows: a. Taxable portion (the amount required to be included in gross income because of the conversion or rollover) first, and then the b. Nontaxable portion. 3. Earnings on contributions.” I’m in agreement that you shouldn’t use a Roth IRA as an emergency fund, but one of you primary reasons is blatantly incorrect which is especially funny because you called other blogs as “wrong” without actually doing a fact-check. Reply

Louie says 30 March 2016 at 18:30 If you make 12 – 18 purchases a month for anything, put your emergency funds in a high-yield checking account. My bank pays 3% interest on amount up to $10,000. I use the monthly interest on my accounts… I own two… to buy high risk ETFs on the Robin Hood app, fee free. The tax consequence on even $20,000 is nominal, and the small amount that those ETFs make tends to offset what Uncle Sugar hits me with. Reply

LCGt9 says 30 March 2016 at 18:35 I believe you are incorrect about Roth IRA withdrawals and this percentage breakdown. Bogleheads forum has some simple language surrounding this that isn’t as complex as the IRS language. Regarding Roth IRA’s: Regular Contributions can be withdrawn at any time with no tax and no penalty. Reply

Tonya says 02 April 2016 at 20:57 I agree that the 80/20% thing is incorrect. I have personally taken out money from my Roth up to the level of contributions and not been penalized. I did it in 2013 and 2014 and unfortunately forgot to fill out the correct form showing how much I had in contributions. So they sent me a letter telling me I owed some huge chunk of money and I filled out the correct paperwork and sent it in and they were satisfied. Both years. I had taken out almost every dollar in principal (long story… had to pay off a car to get my refinancing on my house approved), and they did not consider it 80/20 but were OK with the full amount up to the level of contributions. Reply

Tim Cravens says 30 March 2016 at 19:58 I disagree — the time guillotine and psychology work in FAVOR of my using a Roth as a substantial portion of my emergency fund. If I were to have put the money I put into my Roth into a non-Roth savings account over the last year — there would be no Roth, and as of April 15, no opportunity to ever put it in. Hopefully, I won’t touch it — if I do, well, doesn’t really affect what would have been in the Roth had it not existed in the first place. Second, I personally have a far higher threshold for what constitutes an emergency to withdraw from the Roth than from a non-Roth savings account — I know myself, and this is a major reason that I could never get a substantial emergency fund going before taking Orman’s advice. My Roth is in savings account and IRA’s. Once I reach a certain threshold, everything above that will go into equities. And as I change my behaviors, I hope to build up non-Roth emergency funds — but for now, it works for me. Reply

Bryan @ Just One More Year says 31 March 2016 at 09:29 I like the staggered or ladder approach to having your E Fund in multiple places. Each place serves a specific purpose around the amount saved and the need for liquidity. Of course, I am not following this great advice – ours is a combination of our checking and savings account. (None under the mattress) I am holding off on CD until I have enough set aside to begin putting into 1, 2, and 3 year ladders while rates are so darn low. Also thinking about putting a small portion in an S & P 500 Index fund that would not be touched for at least 5 years or a worst case scenario. Reply

The Finance Games says 31 March 2016 at 21:31 Saving in an IRA seems horrible to me – but I live in and work in an industry where there’s high turnover and firings even if you’re liked and do good work (startups in Silicon Valley). It’s crucial to me to always have that 6 months in online savings, transferred to checking within 3 days. Even a CD can’t really work for my situation. I also have 4-5 various other savings accounts for medicalexpenses, car expenses, savings fund for a laptop emergency, and pet illness emergency, all separated. I don’t plan to touch my Roth IRA at all. Reply

Latoya @ Femme Frugality says 01 April 2016 at 05:45 I’ve certainly heard the arguments that you can use your Roth Ira for emergencies, but it’s something I’ve never considered. I treat retirement accounts as hands off period and when it comes to emergencies, I’m not really concerned about gains. I’m concerned with dealing with the emergency and/or survival. I will more than likely continue to keep saving for retirement and earnings from investments very seperate in the future to avoid over complicating things. Reply

Jamie says 01 April 2016 at 10:47 NEARX ticker is a short muni national that pays 1.5%/year with a $5000 minimum Reply

rosarugosa says 01 April 2016 at 16:24 I enjoy William’s articles and I realize I am unintentionally going with the layered strategy. However, if there is a major known inaccuracy in the article, shouldn’t it be corrected? I am concerned for all those who will read the article and never read the comments. Reply

Jesse Harlan says 01 April 2016 at 16:56 Me and my friend were just discussing this. I think it comes down to personal risk tolerance, your family needs, and your needs for cash. For instance I have many children and a rental property so I need access to funds pretty quickly just in case. But a single person who lives in an efficiency apartment and rides a bike to work may be able to hold less – or put a greater proportion of emergency funds in a brokerage account. Like your article – thanks. Reply

elenagraziela says 02 April 2016 at 13:55 “Emergency” is a strange word. I hear “emergency” and I think I (or someone I care about) is stranded or hurt without help — something has happened to one of my people. If something breaks in my house or if my car breaks down, that falls into a different category, and I build savings for repairs and replacement of those things. My retirement accounts — Roth and otherwise — are hands-off. Always. Dipping into my Roth would be a crazy slippery slope for me. Generally, I don’t use cash for daily or walk-around spending, but I do have an emergency $100 in my wallet. I also have a credit card hidden away in my purse just in case someone steals my wallet. I just need stopgaps to get myself home to take care of whatever might have happened. I have worked freelance for over 10 years, so I’m used to times when things are leaner than others. And I’m solo these days so it makes things simpler — I am sure this is a much tougher issue for those with families. I use credit cards almost exclusively, but never carry a balance. Reply

Tonya says 02 April 2016 at 21:13 I agree that your Roth IRA should not be your main emergency fund. The market is not stable enough to depend on for times of emergency unless your money has been in there a long time and has earned a lot. That said, I keep a few thousand in savings accounts but have used my Roth IRA as a backup emergency fund in case of major repairs on the house or car. When my son smashed the front end of our van, I took some out to cover that then replaced it over time. After going through a bunch of time and money getting ready for a refinance, I was told I needed to pay off my car–my only consumer debt–so I cleaned out the contributions in my Roth and paid it off. I’ll be working to put the money back in every month with my lower house payments. So for me having a Roth as a backup emergency fund has worked out well. I still have $20,000 in earnings left in the account that will sit there tax-free for 17 more years. I’ve also heard Suze Orman talk about using a Roth as a method of saving for college, which isn’t a bad idea. FAFSA doesn’t take retirement funds into consideration when determining financial aid qualification, so it’s not a bad idea. I would recommend taking a year’s worth of college expenses out before the actual college date so you can time the market a little better, but it’s worth thinking about as long as you have some other emergency savings somewhere with less volatility. Reply

Frank Facts says 03 April 2016 at 12:58 While a Roth IRA is most certainly NOT a good place to store an emergency fund, I don’t actually think it’s that bad of a place to store a first-time home downpayment. After 5 years, it can be withdrawn without tax and without penalty. Not bad! Reply

Shobir says 12 April 2016 at 02:50 I like to keep my Emergency Fund in a Fixed Term account where it is earning profits. The account has a 12 month term. If I do experience any emergencies I use credit cards which have a 12 month interest free period. I just keep paying the minimal interest and then when the 12 months is over I pay it off in full because I’ve made a withdrawal request when I had the emergency. Reply

Funny about Money says 15 April 2016 at 18:26 Prepaid debit card? That sounds a little too risky for my taste. All it would take is for someone to steal your purse, and you could say good-bye to that emergency stash. When I was working, I always had three emergency-savings stashes: * A short-term savings account in the credit union: enough for surprises in the $2000 to $3000 range. This could be withdrawn without incurring a tax liability. * A money market fund at Vanguard: enough to cover a pretty large unplanned expense. Tax on withdrawals from this would be very low. * A short-term corporate bond fund at Vanguard: several tens of thousands of dollars; combined with the other two, enough to cover something verging on catastrophic. Everything else resided in IRAs and a 403(b). Now that I’m retired, it’s all one giant emergency fund. :-) Reply

Get Rich Slowly Editors says 01 June 2016 at 17:26 Thank you for sharing Vicky! — Katie Reply

cjchef says 23 April 2016 at 17:01 I prefer to use a ladder of Series “I” bonds. They are not liquid for the first 12 months, so I ladder 25% of my emergency fund every 12 months. I never had less than 75% of my emergency fund liquid. Now my entire emergency fund is indexed to rise with inflation. Reply

Daniel Greegor says 31 May 2016 at 08:36 The withdrawal of Roth IRA contributions is not taxable. Not sure where the information originated but it is WRONG! Reply

Get Rich Slowly Editors says 01 June 2016 at 15:12 Hi Daniel, Withdrawals from a Roth IRA can be taxable in certain circumstances per IRS. Here you go: http://www.irs.gov/publications/p590b/ch02.html#en_US_2015_publink1000231057 — Katie Reply

John says 16 June 2016 at 13:15 The author is 100% incorrect on Roth IRA withdrawal rules. Roth IRAs have FIFO treatment – first in, first out. All money withdrawn that is less than the maximum contributed amount is considered principal (basis) and is thus not taxable. There is no pro-rata distribution from a Roth IRA. The author is confusing Roths with traditional IRAs that have basis (post-tax money). You lose all credibility when you make statements like that. Reply

Tyler says 12 June 2016 at 21:07 I currently keep my emergency fund in a CD. I put $10,000 in it three years ago, and every year it gets automatically renewed. It’s nice to see it grow, it’s even better to know that I never had to touch it since I set up the fund (knock on wood.) Great post! Reply

Komrad says 06 October 2016 at 21:40 I did a withdrawal of $3000 of my Roth IRA basis last year. Taxes due? $0. Reply

Komrad says 06 October 2016 at 21:48 nah, I have an entire years income available in credit for emergencies, and I can take my sweet time getting withdrawing my basis money from the Roth. In the last 5 years I haven’t needed my emergency funds, and that is 5 years at 10% growth over 5 years at .016% growth I would have made in savings. Reply

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How to Build an Emergency Fund - Get Rich Slowly

HOME ABOUT ARCHIVES The Complete Guide to Building an Emergency Fund 58 Comments posted by William Cowie on 30 March 2016 New here? You may want...

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