Financial Planning for Generation X & Y Women
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Expert Q&A Archive

Is is wise to use a Post Tax 401K for an Emergency Savings Fund?
My company 401k plan allows for "Post Tax" contributions and I would like to use this mechanism as a way to build an Emergency Savings fund. Is it a good idea to use post tax savings in a 401k plan as an Emergency Savings Account?

First of all, I always max out the "Pre Tax" portion of my 401k plan. After that, I have thought about using the Post Tax portion of the plan to build an Emergency Savings fund. In this way, I think I can maximize the returns on my Emergency Savings fund. As I understand it, I can withdraw my Emergency funds (other than the interest earned on those funds) without paying taxes or penalties. If I withdraw all of the money in my Emergency fund, then I will have to pay tax on any interest earned. Does this sound reasonable or will I find it difficult (or expensive) to get to my Emergency Savings when I need them?

I guess I could use a Roth IRA in the same manner.
Christina Gears:
expert info »
If your Post Tax contributions will be invested in the market, it would not be a good idea. The market should only be used for “long term” investing. If your 401K has a guaranteed bucket that you could use then you would only be able to use the money you deposited. You would not want to pay tax on the interest. I believe it would be the same and a lot easier to have a money market fund draft your checking account each month for the desired amount for your EC.
Gary Silverman, CFP®:
expert info »
An Emergency fund needs to be liquid. Liquidity implies that you can access the money quickly (after all, it is an emergency) and that the money does not lose value. While I applaud your efforts to make your money work harder, it is much more important that your emergency fund money is intact than it is that it grows.

Your 401k misses on several marks. First, it is difficult to access. While your employer may allow borrowing from your 401k plan, this can sometimes take weeks to set up (depending on the provider). You will also need to start paying this money back immediately. Your emergency may not make this possible. Your "maximizing returns" will likely also maximize risk. Thus at the same time you need your emergency fund, you might find yourself having taken a loss. You'd then need to liquidate, locking in the loss, at this inopportune time.

The idea of using a Roth IRA is a bit more interesting. In fact, I often use Roths for younger couples that are just getting started. The advantage is that principle can be withdrawn at any time with no taxes or penalties. Should you choose to go this route, realize that you still have the potential of losing money if you invest in anything other than a "safe" security such as a savings account or CD.

If you truly insist on going for the gusto, realize that stocks can lose 50% of their value in the short-term even if your portfolio is well diversified. This happened to Peter Lynch's Magellan fund in the early 70's. My guess you are no better an investor than Lynch, so watch out. Ensure that if you are counting on a "maximum return" portfolio for emergency funds that only half of the starting value may be there when you need it.
Connie K. Marmet:
expert info »
A key factor is how likely you are to draw on the emergency fund. If you are only concerned with the one in a million emergencies, the 401(k) allows you to defer taxes while saving. If there is a high probability that you will draw, savings outside of the 401(k) may be preferable. First your funds are more accessible. Second, if you leave your current employer you may have to repay the loan so check your plan carefully on this point.
Susan Saleem:
expert info »
It's good to hear that you are maximizing your pre-tax dollars to your 401k and working on an emergency fund. I would suggest setting up an automatic deduction to a Roth Ira because your access to a 401k can be cumbersome. Emergency funds need to be easily accessible and there are often restrictions made by an employer on when and how you can take distributions from a 401k. You can take out your contributions to a Roth at any time. Any earnings would need to remain in the fund at least 5 years or you would be subject to both tax and 10% penalty.
Fara Goodwin:
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There are maximum allowable limits of what you can deposit (post or pre tax) to an IRA. As a federal government benefits advisor, I can not provide financial advice. I can however, articulate the processes necessary in order to obtain funds from a 401(k).

First off, 401(k) plans were not designed as emergency savings plans, they were designed as retirement plans. A savings account allows you to withdraw money as needed. A 401(k) at best, offers a loan provision which must be repaid.

There are numerous processes that you would have to satisfy before withdrawing money from a 401(k). You would have to qualify for the loan based on the Plan's provisions. The requirements would be articulated in your Summary Plan Description.

An application for distribution is submitted to the Plan Administrator. The Plan Administrator valuates the account, ensures that the loan is in compliance with the Plan and petitions the trustee for a letter of release or authorization to distribute the funds. There are differing methods distinct to the employer, that can be used to effectuate a distribution/loan. This process can take up to several weeks.

I hope that this information is helpful to you in determining to use a 401(k) as an emergency savings plan.