Use caution when using Roth money for emergencies

Among the multitude of ideas that readers have submitted for building an emergency fund, here's an intriguing one: Use a portion of your Roth IRA. Although I have misgivings about it, the concept is worth a look.
"My wife and I have an emergency fund equal to three-fifths my annual salary," said Robert Jones, a reader from Pennsylvania. "We keep it in a bond mutual fund as part of our regular brokerage account. We also have Roth IRAs with the same broker.
"Might we be better off keeping that emergency fund as part of our Roth IRAs? The contributions would still be available, without penalty, for any purpose, and the interest would grow tax-free. We can keep it in the same bond fund or a similarly conservative investment within the Roth accounts."
For those who need a refresher, a Roth IRA is a type of individual retirement account that, unlike a traditional IRA, does not offer a tax deduction on contributions. But all withdrawals can be tax-free once you are 59 1/2 and have had a Roth IRA open at least five years.
Another advantage is that, since you've already paid taxes on the money you contribute, you can always withdraw your direct contributions, at any time and for any reason, without taxes or penalties (although this has been the case since Roth IRAs came into being in 1998, this fact is still not well-known).

For example, if you have a Roth IRA worth Advertisement
$25,000, and $18,000 of it is direct contributions and $7,000 is
earnings, you can always take out the $18,000 tax and penalty-free. (If a bank imposes a penalty for the early redemption of a certificate of deposit in a Roth IRA, that's another matter unrelated to the tax laws.)
It is possible, therefore, to use a Roth IRA as an emergency fund. If you need the money, it is there for you. If you don't need it, you can leave it alone to grow tax-free for retirement.
But a few caveats are in order: A Roth IRA is intended to be an account to save for retirement. Using it for any other purpose may leave you short of funds after you quit work. If you do rely on a Roth IRA for emergencies, you must have the discipline to avoid raiding it for nonemergency expenditures.
Also, as retirement savings accounts, Roth IRAs are ideal vehicles for long-term growth-oriented investments such as stocks and stock-mutual funds. Emergency funds are best kept in stable, short-term investments that can be converted to cash quickly without loss of principal (although low-volatility bond funds can be used, I prefer money market funds that don't fluctuate in price).
Therefore, before using part of your Roth IRA as an emergency fund, you need to consider whether such use fits within your overall asset allocation (in other words, how you want your money divided among different asset classes, such as stocks, bonds and cash, based on your goals and risk tolerance).
Say you want a portfolio of 60 percent stocks, 35 percent bonds and 5 percent cash. If the 5 percent cash allocation fits into your Roth IRA and gives you enough money to handle emergencies, then the idea can work. In this instance, you may leave 5 percent of your overall portfolio in a money-market fund within a Roth IRA. Top-yielding money funds are paying 5 percent or more today, and you can leave everything to grow tax-free inside the IRA if you don't need the money for emergencies.