The 1 Roth IRA Mistake You Can't Afford to Make

A Roth IRA is one of the most powerful retirement tools available. It offers tax-free growth, tax-free withdrawals in retirement, and the flexibility to avoid required minimum distributions.

That's not the only flexibility you'll enjoy with a Roth IRA, though. These accounts also give you easy access to your funds if you need them ahead of retirement in a pinch. Whether that's a good thing, however, is questionable.

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Why your Roth IRA shouldn't double as an emergency fund

Unlike traditional IRAs, where contributions go in on a pre-tax basis, Roth IRAs are funded with after-tax dollars. Because of this, your principal contributions are accessible to you at any time without a penalty.

With a traditional IRA, there's a 10% early withdrawal penalty that applies to distributions taken before age 59 and 1/2 (with a few exceptions). With a Roth IRA, that penalty is waived as long as you limit withdrawals to principal contributions. So if you need money in a pinch, you can tap your Roth IRA rather than be forced to borrow or scrounge up the cash some other way.

That might seem like a good thing at first. But using your Roth IRA as your emergency fund is a move that could seriously backfire on you.

The main issue is that once you take money out of a Roth IRA, you generally can't put it back. Contributions are capped each year, so if you withdraw $15,000 at age 35 to cover an emergency, that money can't just get returned to your account.

Here's where that really becomes a problem. Roth IRAs aren't mean to sit in cash. Ideally, you're investing yours in a variety of assets. But when you take an early Roth IRA withdrawal, you lose out on the opportunity to grow that money into a larger sum.

Let's say your Roth IRA delivers an 8% annual return, which is a bit below the stock market's average return. If you take that $15,000 withdrawal at age 35, by age 65, you'll have lost out on almost $151,000 when you account for lost gains. That's a lot of money to not have for your senior years.

Build a true emergency fund instead

It may be nice that Roth IRAs offer flexibility when it comes to the money you put in. But if you're funding a Roth IRA to have a strong retirement nest egg, your best bet is to leave that money alone during your working years -- period.

As for emergencies, it's always a good thing to have cash available for unplanned bills. But rather than let your Roth IRA double as an emergency fund, you should instead actively build your own cash safety net.

For many people, a three- to six-month emergency fund can suffice in covering a period of unemployment or other large expenses that aren't routine. And that way, you can reserve your Roth IRA for what it was originally meant for.

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