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Dr. Don Taylor, CFA, Bankrate.com advice columnistSome thoughts on emergency funds

Dear Dr. Don,
I'm 51 years old and have about $400,000 socked away in 403(b) and Roth IRA accounts. Right now I have about four months' salary as an emergency fund. I read in a lot of places that a six-to-nine months "buffer" is better. Can I tap into my Roth account principal (contributions net of earnings) just in case?
-- Kuko Cache

Dear Kuko,
I'm in the three-to-six month camp when it comes to sizing an emergency fund, and I base that on monthly expenses, not monthly salary. After all, it's having the liquidity to meet your current expenses that's the goal here.

People whose income varies a lot from month-to-month or year-to-year should have a larger fund than people with a steady income. Other factors would include your health, job security, equity in your home and the size and composition of your investment portfolio -- including your retirement accounts.

Having a home equity line of credit (HELOC) in place can reduce your need for an emergency fund; so can the ability to borrow against the cash value of your life insurance policy, access to 403(b) plan assets or original contributions to your Roth IRA accounts.

Withdrawals of your original contributions to a Roth IRA aren't taxable, but withdrawing investment earnings may be both taxable and subject to a 10 percent penalty tax if the distributions are made prior to age 59½ and aren't used for a qualified purpose such as a first-time home purchase, higher education expenses, qualified medical expenses, health insurance expenses during a period of unemployment, disability or death. The tax issues surrounding withdrawal of earnings from a Roth IRA are such that you should consult a tax professional prior to taking those distributions.

Over time most people gain a measure of financial flexibility that allows them more than one alternative in meeting a financial challenge. The more flexibility you have with your finances, the less important it is to have a large emergency fund. For readers who don't have an emergency fund in place, a CCH calculator will help you size your fund.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & investing" or "Money."

Bankrate.com's corrections policy -- Posted: March 29, 2006
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