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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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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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(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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