A friend called me a few weeks ago wondering if I had time for a personal finance question. I was watching “Shark Tank,” so I was primed for a talk about money! He’s upgrading to a bigger house and needed some short-term liquidity for the pesky new-construction financing. He’s very analytical, so he ran the numbers up, down, and sideways and was very confident with the house decision and options for liquidity. His specific question was whether he should consider tapping his Roth IRA to meet the loan down payment because he didn’t have the immediate funds in his taxable accounts and didn’t want to take a 401(k) loan. Because Roth IRA contributions are made with after-tax dollars, they can be withdrawn tax- and penalty-free at any time. When he asked my thoughts, my response was, “I used mine when I bought my house.” He asked if I had any regrets and, without any hesitation, I said absolutely not.

Because his approach on the overall home purchase seemed sound, we focused the conversation on how he viewed his Roth IRA. Mentally, he was only struggling with touching his Roth because it’s an IRA and he viewed it solely as retirement savings. If the money were in a taxable account, he’d have no reservations about using it. I gave him kudos for his logic, but I reminded him that a Roth IRA provides a level of liquidity that shouldn’t be overlooked.

First and foremost, a Roth IRA is a tax-advantaged retirement account, and disciplined investors should treat it as such. One of the best ways to build wealth is to maximize annual retirement plan contributions, including employer-sponsored plans and IRAs, but as I’ve written before and explained to my friend, there are perks specific to a Roth IRA. One advantage is the ability to access contributions (or conversion dollars, after meeting holding-period requirements[1]) if you ever need to, so these dollars can be viewed as a liquidity account.  This is a planning strategy I discuss with young investors. Often, they’re income-strapped, so saving for retirement while building an emergency reserve is a struggle. (Consider telling a millennial who is paying down a mountain of student debt to save 12–15% of her salary while building 3–6 months of living expenses in an emergency fund. It’s a bitter pill!) Building a Roth IRA with the knowledge that all contributions are accessible, while still maintaining some level of cash reserves, is one option for a strong and flexible financial foundation.

The main drawback of tapping your Roth means that you lose compounding opportunities on any money you withdraw, which, depending on the amount and time horizon, can make an unfortunate dent. (There is one way to put the money back, if you have the means, within the 60-day rollover window.[2])

The conversation with my friend delivered enough peace of mind to help him overcome the mental accounting hurdle to think through all of his options. He ended up taking a withdrawal from his Roth and moved ahead with his house plans. Similar to my situation, the dollar amount was relatively small. When I took a withdrawal, it was additional liquidity that I wanted even though I knew I’d give up the compounded tax-free earnings. But I’m diligent and invest in my Roth every year, building up my retirement account while knowing I have flexibility to access the contributions if I ever need to.




[1] Roth withdrawals are assumed to be in the following order: contributions, then conversions, and lastly earnings.  Account owners under the age of 59 ½ who withdraw conversion dollars and don’t meet the IRS-approved exceptions will face a 10% penalty. There are no taxes on earnings as long as you’ve held the account 5 years, you’re age 59 1/2 or older, or a special exception applies. Withdrawals from traditional IRAs are assumed a pro rata share of pre-tax contributions, earnings, and post-tax contributions (your basis). Generally, if you make a withdrawal from a traditional IRA and you’re under the age of 59 ½ you’ll be subject to income tax and a 10% penalty.

See https://investor.vanguard.com/ira/roth-vs-traditional-ira for more details.

[2] Beginning in 2015, individuals can make only one rollover from one IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs owned. The limit applies to all of an individual’s IRAs, including SEP and SIMPLE IRAs, traditional, and Roth IRAs. Direct transfers of IRA money (i.e., IRA trustee to IRA trustee) are not limited. For more information, see https/www.irs.gov/pub/irs-pdf/p590a.pdf