Should I Pull Money Out of a CD if I Need It in an Emergency?

Here's what to do if you're in a pinch.

It's always a good idea to have money set aside for emergencies. And the best place for your emergency fund is none other than a savings account. 

You definitely don't want to invest the money you have earmarked for unplanned expenses, because if your portfolio tanks when you need to take a withdrawal, you could end up in hot water. And it's not the best idea to keep your emergency fund in a certificate of deposit, or CD, since these accounts are more restrictive than savings accounts.

When you open a CD, you're asked to commit to keeping your money in place for a preset period of time. That could be six months, one year, or longer. 

The downside of opening a CD is risking a penalty if you cash it out before it comes due. The upside, however, is earning a higher interest rate than what your savings account gives you.

You may, at some point, decide to put extra money you have into a CD. But what if you run into an emergency situation that your regular savings account doesn't have enough money to cover? Should you tap your CD?

Sometimes, it pays to take a penalty

Let's imagine you spend $2,500 a month and therefore chose to build yourself a $7,500 emergency fund to cover three months of living costs. Let's also assume you put an additional $2,500 you had into a one-year CD. 

You may have tied that money up thinking you were all set with regard to your emergency fund, only to then encounter a shocking home repair with a $10,000 bill attached to it. At that point, you technically have the money -- only $2,500 of it is tied up in a CD. What should you do?

If you're forced to choose between cashing your CD out early and racking up a credit card balance, then the former is probably your better bet. You might lose out on three months of interest if you cash out a CD ahead of schedule (technically, each bank can set its own early cash out penalty, but three months is pretty common for a 12-month CD). But the amount of interest you lose could pale in comparison to the amount of interest you rack up on a credit card.

Let's say your $2,500 CD pays 2.5% annual interest. Cashing it out means taking a penalty of around $16. Meanwhile, if you charge $2,500 on a credit card with an 18% interest rate and it takes you a year to pay that debt off, you'll end up spending $208 on interest. So in this case, giving up around $16 in interest is an easy call.

Be careful when opening a CD

In some cases, losing out on a few months of interest by cashing out a CD early may not be a big deal. But all told, you should really only put money into a CD if you're truly confident you won't need it before that CD comes due. Otherwise, you may want to just play it safe and keep more of your money in a regular savings account, even if that means giving up a slightly higher interest rate.