Gyroscopic Investing

How does one treat a portion of their 401k as an emergency fund?


I have some cash in mine that i would like to either invest in a fund ( fidelity new market index , FNMIX) within my 401k as part of my emergency fund allocation or simply count it as emergency fund cash. This same 401 K account holds the vanguard 500 index (VFINX) which i use for my equity portion of the permanent portfolio as well as cash for PP re balancing purposes. The other funds in my emergency fund are held in a regular vanguard brokerage account.

Is there any way to do this conceptually and as tax efficent as possible assuming i ever needed access to said emergency fund?

Thanks.

I count all the cash in my PP as my emergency fund. Cash in tax-sheltered accounts is a bit of a sticky issue, but my idea on this front (which I admit I've never implemented) is to roll over the cash you need in your 401k into an IRA, and then from there into a Roth IRA, paying the taxes as required. Once it's in the Roth IRA, you can withdraw it since it's a contribution and Roth contributions are withdrawable penalty-free. This avoids the 10% penalty.

Of course, it would be best to tap your cash in taxable accounts before doing this due to the time and hassle required to pull it off.

I've never nor do I intend to do this but you could always get a loan from your 401k for an emergency and then pay it off by adding more into your 401k later.

1NV35T0R (Greg) wrote: I've never nor do I intend to do this but you could always get a loan from your 401k for an emergency and then pay it off by adding more into your 401k later.

I believe federal law requires you to pay it off in at least monthly installments, with interest.  Usually while employed it is via payroll deduction.  Make sure your cash flow can support those payments.

I believe the interest paid is always credited to your account, so taking a 401(k) loan is analogous to your 401(k) buying a bond.  If you don't pay it back, it is like a default and your 401(k) is out the money.  You may be able to increase your regular contribution to make it up.  But if you could afford to do that, why didn't you pay back the loan?

Two things to watch out for:  fees (at start, annual, and per payment); and payment terms should you lose your job (commonly the entire outstanding balance is required to be paid immediately, but some company plans allow making the same monthly payment until the loan is paid, sometimes adding additional fees).

Obviously being required to pay off the entire balance if you lose your job could be a problem. If you cannot pay, the balance will be treated as a withdrawal and you'll owe the normal taxes and penalties you would have owed had you taken that amount as a withdrawal.

I've done a 401(k) loan.  I did it because layoff rumors were strong, and I knew the terms of my employer plan at the time had low fees (only an initial fee of $50) and allowed payments to continue after employment terminated.  It all worked out great.

But I don't believe you can take a loan after you become unemployed.  Some emergency fund.


Another source of emergency funds is a home equity line of credit.  Again, watch for fees.  And be aware that the lender can typically at will reduce or eliminate your unused credit (which they almost certainly will should they decide you are a poor risk, e.g. you lost your job).

Edited to improve clarity and reduce typos.

jwart wrote:
How does one treat a portion of their 401k as an emergency fund?


I have some cash in mine that i would like to either invest in a fund ( fidelity new market index , FNMIX) within my 401k as part of my emergency fund allocation or simply count it as emergency fund cash. This same 401 K account holds the vanguard 500 index (VFINX) which i use for my equity portion of the permanent portfolio as well as cash for PP re balancing purposes. The other funds in my emergency fund are held in a regular vanguard brokerage account.

Is there any way to do this conceptually and as tax efficent as possible assuming i ever needed access to said emergency fund?

Thanks.

Many 401ks will allow you to "borrow" money from yourself.  Check and see if yours has something like this.

You don't. Many debate the duration of funds to hold in the event of an emergency (12,18 or 24 months), but almost all agree that a portion of the funds should remain accessible at a moment's notice. Personally, I would invest in a tax-exempt bond fund (in taxable) and consider this tier 1 of the emergency fund. The balance can exist in a 401K. but consider the time required to process the request and cash the check.

401K is not a great emergency fund option.  I think the only way to get cash out without paying the 10% early withdrawal penalty is to qualify for a hardship withdrawal.  A Roth IRA could work, but note that contributions can be withdrawn only after a 5 year incubation period, so rolling 401K money through it at the time of the emergency won't work.

I personally favor a combination of savings accounts, short term treasuries in taxable, and I Bonds for the emergency fund.  Note that the stability of the rest of the PP makes it useful as deep emergency money, if you have some of each of the volatile assets in taxable.  It's a lot more reliable than a typical stock-heavy portfolio would be.

sophie wrote: A Roth IRA could work, but note that contributions can be withdrawn only after a 5 year incubation period, so rolling 401K money through it at the time of the emergency won't work.

Contributions can always be withdrawn tax-free and penalty-free.  The 5-year period relates to qualified distributions.  From IRS Pub 590:

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s).

And from an e-mail I got from Vanguard as part of a related question:

While you can withdraw your Roth IRA contributions at any time- tax and penalty free,

I agree that the IRS rules are not clear on this matter.  Here's a link to a blog article that walks through the logic:

http://www.mymoneyblog.com/can-i-really ... nalty.html

jimbojones wrote:
Contributions can always be withdrawn tax-free and penalty-free.  The 5-year period relates to qualified distributions.  From IRS Pub 590:

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s).

I also like the flow chart in pub590, just don't get confused about what is a return of contributions and what isn't.  irs pub 590  See the "Ordering Rules for Distributions" just under Figure 2-1.