Can I Tap My IRA Early if I'm Laid Off?

The purpose of an IRA is to build up a nest egg for retirement. And the IRS tries to do its part to encourage workers to save in an IRA by offering tax incentives.

The money you contribute to a traditional IRA will go in on a pre-tax basis. So if you put $3,000 into one of these accounts, that's $3,000 of income you won't pay taxes on.

Plus, when you invest funds in your IRA, you won't be charged taxes on your gains year after year. Rather, those gains will be tax-deferred, so you won't pay the IRS on your gains until you're ready to take withdrawals.

But because there are so many tax breaks associated with IRAs, the IRS imposes some pretty strict rules on these accounts. One such rule is that you're not allowed to tap your balance before age 59 1/2. Doing so will generally mean facing a 10% penalty on the sum you remove. So if you take a $10,000 IRA withdrawal at age 40 to pay for a car repair, you'll lose $1,000 of that right off the bat.

Now, you may be wondering if there's an exception to that 10% penalty if you lose your job and need your IRA to pay your bills. Unfortunately, there isn't. So it's important to have a better backup plan for that situation.

Unemployment doesn't qualify for an exception

There are certain things you can take an early IRA withdrawal for without facing a penalty. For example, you can withdraw funds to pay for higher education and take up to $10,000 out of an IRA penalty-free to purchase a first-time home.

But unfortunately, there's no rule stating that your 10% early withdrawal penalty will be waived because you happen to be unemployed and need your IRA funds to pay your bills. So if you take a $2,000 withdrawal at age 35 to make your rent and car payments, you'll face that hefty penalty.

Now that said, one thing you can take a penalty-free IRA withdrawal for at any age is the cost of health insurance premiums while you're unemployed. But that exception is limited to the cost of those premiums alone, and other expenses or needs related to unemployment don't qualify.

Always have a separate emergency fund

You never know when you might lose your job unexpectedly. And unfortunately, your IRA isn't a good account to tap in that sort of situation. Not only will you generally face a 10% early withdrawal penalty if you're not yet 59 1/2, but funds you remove from your IRA will represent funds that won't be available to you as a senior, when you might need them the most.

Remember, if you lose your job in your 30s or 40s, you might be unemployed for a couple of months. During retirement, you're pretty much unemployed for the rest of your life. So it's important to try to preserve your IRA balance as best as you can.

A better way to cope with unemployment is to build up an emergency fund to tap. Ideally, aim to put enough money into a savings account to cover at least three months of essential living costs.

If you end up losing your job, you'll have the option to tap your savings without restriction. And that way, you won't have to add insult to injury by getting penalized for accessing the money you worked hard to sock away.