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If my understanding is correct, you can take out your contributions from your Roth IRA whenever you want without paying any penalties.

If this is true, then other than the limit you can contribute to it every year, what is a good reason for not using it as a savings account earning a higher, tax-free return (though not accessible until retirement), while regular savings accounts today earn practically nothing?

Chris W. Rea
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  • What kinds of investment choices would you make in the Roth IRA? This would be the challenge to my mind. – JB King Dec 08 '14 at 22:41
  • @JBKing Even the safest kind of investments (Government Bonds) earn a yearly minimum of 2%-4% compared to a sad 0.1% in savings accounts. –  Dec 08 '14 at 22:45
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    @YasmaniLlanes: So why not just buy bonds in an ordinary investment account? Going through the Roth IRA doesn't gain anything. – Nate Eldredge Dec 08 '14 at 22:46
  • @NateEldredge I'm thinking because I would have to pay taxes on the earnings, dropping the 2%-4% earnings below inflation levels. –  Dec 08 '14 at 22:51
  • @YasmaniLlanes: "Even the safest kind of investments (Government Bonds) earn a yearly minimum of 2%-4% compared to a sad 0.1% in savings accounts." You can still have a savings account IRA. – user102008 Dec 09 '14 at 23:36

2 Answers2

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Sounds like a bad idea. The IRA is built on the power of compounding. Removing contributions will hurt your retirement savings, and you will never be able to make that up.

Instead, consider tax-free investments. State bonds, Federal bonds, municipal bonds, etc. For example, I invest in California muni bonds fund which gives me ~3-4% annual dividend income - completely tax free. In addition - there's capital appreciation of your fund holdings. There are risks, of course, for example rate changes will affect yields and capital appreciation, so consult with someone knowledgeable in this area (or ask another question here, for the basics). This will give you the same result as you're expecting from your Roth IRA trick, without damaging your retirement savings potential.

littleadv
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  • I always assumed that you had to pay taxes on government bonds. The only thing that can make an investment tax-free is the account it's in (tax-deferred or tax-exempt accounts). Isn't that right? –  Dec 09 '14 at 18:28
  • While your advice is good for general consumption, individuals might benefit from such a strategy. If they have already maxed a 401k contribution, they may already be adequately funding retirement. As written, I don't think this answers the question. – NL - Apologize to Monica Dec 09 '14 at 19:22
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    "bad idea" compared to what? You're saying that it's a bad idea compared to investing in a Roth IRA long term. Sure. But it sounds like the OP is comparing it to not having a Roth IRA at all, and having a regular taxable account. In that case, it's a better idea. – user102008 Dec 09 '14 at 22:43
  • @user102008 bad idea compared to the idea in the next paragraph of my answer. Have you read that far? – littleadv Dec 09 '14 at 23:33
  • @NathanL the question was "what is a good reason for not using it" while getting tax free income - I provided one reason for not doing, and an alternative. How is it not answering the question? No-one was talking about "adequately funding retirement" (what does it mean, anyway?). – littleadv Dec 09 '14 at 23:35
  • I already have a 401(k), so retirement funds are not a concern. The idea is to have the money sitting on a Roth IRA account growing at a higher, tax free rate, vs a savings account.

    I always assumed that you had to pay taxes on government bonds. The only thing that can make an investment tax-free is the account it's in (tax-deferred or tax-exempt accounts). Isn't that right?

     –  Dec 10 '14 at 00:14
  • @YasmaniLlanes it is not. There are tax-exempt bonds, and depending on your State you can have dividends completely tax free (I live in California, so for me Cali muni bonds are tax free). Talk to your local tax adviser (EA/CPA licensed in your State) to learn about these options – littleadv Dec 10 '14 at 00:36
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(To be clear, IRA accounts are just wrappers, and can contain a large variety of investments. I'm restricting myself to the usual setup of investment in the stock market.)

  1. Once you remove money, you can't put it back; the money still counts for the yearly deposit limit.
  2. There can be issues with time needed to move money from the IRA account to a form you can directly spend.
  3. Stocks can go down.

So, let's say you have $5000 in savings, as an emergency fund. Of the top of my head, putting some of it into a Roth IRA could backfire in the following ways:

  1. You have an emergency, and it takes you a few days to move the money to your checking account to spend it, when you need the money now.
  2. You have an emergency, and the stock market is not in great shape that day. You withdraw your money anyway because you don't have a choice, but you still lose a bunch of money.

The basic principle here is that the stock market is not a good place for storing your emergency cash, which needs to be secured against loss and immediately accessible. Once you're happy with your level of emergency cash, however, tax-advantaged investment accounts are a reasonable next step.

user3757614
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