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A savings account is a bank or credit union account that holds cash deposits. A Roth IRA is a tax-advantaged individual retirement account (IRA) meant primarily for long-term retirement investing. Both savings accounts and Roth IRAs can be a source of money in an emergency. Here are the differences between the two.
Key Takeaways
- A savings account is an interest-bearing account that gives you easy access to your money for emergencies or short-term goals.
- In addition to basic savings accounts, there are high-yield savings accounts that pay higher interest.
- A Roth IRA is a special type of retirement account that can also be a good source of emergency cash.
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Investopedia / Hilary Allison
Savings Accounts
Savings accounts are an excellent place to keep ready cash, such as your emergency fund or money you’re amassing for short-term goals, like a summer vacation or your next car. They can also be a safe place to park money temporarily—such as the proceeds from a home sale—before you invest it elsewhere.
In addition to regular savings accounts, high-yield accounts pay higher interest rates. These accounts are commonly offered by online banks. Savings accounts of either kind are generally insured up to certain limits by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), depending on the institution at which they are held.
Given a long enough time frame, there are other choices. For example, a certificate of deposit (CD) is less liquid than a savings account, but it will often earn you a higher interest rate.
The nominal interest you earn on a savings account is considered part of your taxable income.
Roth IRAs
IRAs are intended for retirement and come in several varieties. Contributions to a Roth IRA are made with after-tax dollars and can be withdrawn at anytime without penalty. The account’s earnings can also be withdrawn tax-free if you have had a Roth account for at least five years and are 59½ or older at the time of the withdrawal. There are also some exceptions to the age 59½ requirement.
Similar to traditional IRAs, Roth IRA earnings compound and participants are subject to annual contribution limits and other rules. However, unlike owners of traditional IRAs or 401(k) plans, Roth IRA owners don’t have to take required minimum distributions (RMDs). Instead, they can leave their money in the Roth IRA for as long as they live and leave it to a designated beneficiary.
Money deposited into a Roth IRA can be invested in various vehicles. Most financial institutions limit those choices to stocks, mutual funds, bonds, and CDs. However, if you set up a self-directed IRA, you can have a wider selection, including real estate, cryptocurrencies, promissory notes, tax lien certificates, and private placement securities.
Note
Life insurance and collectibles are not allowed to be held as investments within an IRA.
What Roth IRAs and Savings Accounts Have in Common
A savings account is all about having accessible cash, and a Roth IRA offers the most accessibility to your savings of any of the tax-advantaged retirement accounts. Because the money you contribute to it is available at any time and for any reason with no penalties, it can be used as an emergency fund. With traditional IRAs and 401(k) accounts, you’ll pay income taxes and possibly an additional 10% early withdrawal penalty to access even your contributions.
Typically, having emergency savings totaling three to six months of income is a good idea in case you ever need money in a hurry. A Roth IRA can be useful for this purpose, as you can withdraw your contributions anytime. However, there are two catches:
- No redeposit: You generally can’t redeposit the Roth money you removed should you want to replenish your retirement savings. There is an exception: You can take a short-term loan from your IRA if you redeposit it within 60 days. This process is not intended to be a loan, but is actually an IRA rollover, except you'll put the money back instead of putting it into a new retirement account. This can be done only once a year.
- Annual contribution limits: For 2024, the standard limit is $7,000, and the limit for those 50 and over is $8,000.
Frequently Asked Questions (FAQs)
Is a Savings Account Good for Saving for Retirement?
No. Retirement accounts are set up expressly to help people reach their goals of having enough money in their post-work years. Savings accounts are far simpler and meant for short-term and emergency needs.
What Are the Advantages of a Roth IRA?
The biggest advantage of a Roth IRA is that if you follow the rules, you won’t pay taxes when you take distributions. In addition, Roth owners aren’t subject to RMDs at age 73 as owners of traditional IRAs or traditional 401(k) accounts are. Roth funds can be invested in various vehicles, such as stocks, mutual funds, bonds, and CDs. If you set up a self-directed IRA, you can even invest in real estate and cryptocurrencies.
Are Roth IRAs Insured?
Only certain holdings are insured. Cash deposits held within Roth IRAs are insured for up to $250,000 by the FDIC and NCUA. For example, if you have a CD within your IRA it will be covered by deposit insurance. However, insurance does not apply to securities such as stocks, bonds, mutual funds, ETFs, and other popular investments often held within Roth IRAs. So most people's Roth IRA holdings would not be protected by this insurance.
The Bottom Line
Both savings accounts and Roth IRAs have their purposes. Savings accounts can be a safe place to keep cash for emergencies and short-term goals. Roth IRAs are for long-term goals, primarily retirement. However, Roth IRAs can also be used for withdrawals in an emergency because your Roth contributions are always accessible without penalty. However, your earnings are not.