3 Reasons Your IRA Can't Be Your Emergency Fund

It pays to keep money in the bank for unplanned bills.

You never know when you might get hit with an unexpected bill your regular paycheck can't cover, whether it's a home repair, car repair, or medical bill. At that point, you'll need money to pay that expense or otherwise risk credit card debt. And that's where your emergency fund comes in.

The best place for your emergency fund is a savings account -- one you can access easily at all times. If you have money in an IRA earmarked for retirement, you might assume you don't really need a separate account for emergencies. After all, if you have thousands of dollars just sitting in your IRA, can't that stash bail you out?

But counting on your IRA to serve as your emergency fund is a move you might regret. Here's why you should have a dedicated emergency fund outside of your IRA.

1. You'll be penalized for early withdrawals

Removing funds from an IRA prior to age 59 ½ will generally result in an early withdrawal penalty. And that penalty will amount to 10% of the sum you remove. So, let's say you get stuck with a $3,000 home repair bill and you raid your IRA to cover it. You'll lose $300 of that off the bat for tapping your account too soon. 

2. You might lock in losses by withdrawing funds at the wrong time

Your IRA shouldn't just sit in cash. Rather, you should invest your IRA so it's able to grow into a larger sum of money over time -- enough to sustain you during retirement. But if you're forced to turn to your IRA to take a withdrawal at a time when your investments are down, you might lock in losses in that account that hurt you on a long-term basis. 

3. You'll short yourself on actual retirement savings

The purpose of having money in an IRA is to ensure you have a means of paying your bills once you retire and stop earning a paycheck from work. Sure, you'll probably get Social Security. But those benefits won't cover all of your senior living expenses, so you'll need additional funds from your own savings. 

But if you raid your IRA every time an emergency strikes, you'll end up with a lot less money once retirement rolls around. And that could result in a major cash crunch later in life, which isn't what you want. 

Plus, remember that every time you take money out of your IRA, you lose the opportunity to invest that money and grow it into a larger amount. So for example, taking a $3,000 withdrawal to cover a home repair could mean retiring with $23,000 less when you account for lost gains in your account.

Have a separate emergency fund

Tempting as it may be to look to your IRA as your emergency fund, you're much better off keeping money in a separate savings account for unplanned bills. That way, your IRA can serve its intended purpose -- being a source of money to rely on during your senior years.