We all know it’s important to have a savings account in case of an emergency. The general rule of thumb states that you should save enough to cover 3-6 months’ worth of living expenses. However, what if you’re nearing retirement? Is it still as important to add to your savings account? Or should you put that money towards your retirement instead, and then use your retirement accounts as a backup emergency fund? Below we cover some of the key implications to consider when tapping into your retirement assets:
With a traditional IRA, there’s no early withdrawal penalty as long as you’re older than 59 ½. However, according to a recent Kiplinger article, this is not a good idea for a couple reasons. You’ll pay taxes on any withdrawals which could put you in a higher tax bracket. In addition, you might have to sell in a down market. Since the annual contribution limit on a traditional IRA is $6,500 for those 50 or older, you may not have time to recoup your losses and get back to where you need to be.1
What about using your Roth IRA instead? IRS rules allow you to withdraw contributions without taxes or penalties. If you’re 59 ½ or older, and have held the Roth for at least 5 years, you can also withdraw earnings tax and penalty free. This seems like a win, win; however, industry professionals don’t recommend this option either. The article states that “Tapping a Roth undermines one of its biggest advantages: You don’t have to take distributions starting at 70 ½, as you do with traditional IRAs. Better to leave a Roth account intact so you can deploy after-tax money strategically in retirement or let it grow.”1
Borrowing from your 401(k) for emergencies is a better option since you won’t pay taxes. You will pay interest, but since you’re paying it to yourself, you’ll ultimately benefit from this strategy. The rules typically allow you to borrow up to half the amount of your 401(k) balance – up to a maximum of $50,000. However, it’s important to be aware that you must repay the loan right away if you lose or leave your job.1
Many homeowners don’t think of their home as a source of wealth. However, accessing your home equity through a reverse mortgage or Home Equity Line Of Credit (HELOC) can be a good option for emergency funds. The article advised borrowers to resist the temptation to expand their definition of “emergency” when tapping their home equity. Doing so will help to ensure the cash is available when you need it.1
A Home Equity Conversion Mortgage (HECM), commonly known as a reverse mortgage, is a Federal Housing Administration (FHA) insured loan. A reverse mortgage enables seniors 62 and older to access a portion of their home’s equity to obtain tax free2 funds without having to make monthly mortgage payments.3 You can receive your loan proceeds as a lump sum, monthly payments or via a line of credit to use when needed. The loan typically becomes due when the borrower moves out of the house as their primary residence or passes away.
If you’d like to learn more about reverse mortgages, please use our Reverse Mortgage Calculator or call 800-218-1415.
1 Do You Still Need an Emergency Fund as You Get Older? – kiplinger.com, by Jane Bennett Clark, July 2016, http://www.kiplinger.com/article/saving/T023-C022-S002-do-i-need-an-emergency-fund.html#.
2 Consult your financial advisor and appropriate government agencies for any effect on taxes or government benefits.
3 You must live in the home as your primary residence, continue to pay required property taxes, homeowners insurance and maintain the home according to Federal Housing Administration requirements.
Author: Meredith Manz