Early Withdrawal Tax Penalty

• Under normal circumstances, the IRS assesses a 10-percent penalty tax if you take an early distribution from your IRA prior to turning 59 1/2. Certain exceptions apply to the rules governing this penalty, however, and the purchase of your first home is one of them. You may withdraw money from your IRA penalty-free to buy your first home regardless of your age. Don't be fooled, though. You must meet certain IRS criteria in order to qualify as a first-time home buyer, and the IRS still assesses income tax on the distribution in most cases.
  
  

Qualifying Criteria

• To officially qualify as a first-time home buyer and avoid the 10-percent early distribution penalty tax, you cannot currently own a home, or previously owned a home for two years prior to the acquisition date of the home you want to buy. The acquisition date is either the date on the home's purchase contract, or the date when home construction or remodeling begins.
  
  You must also:
  
  1. Use the distribution for you and/or your spouse's first home, or the first home of your child, grandchild, parent or ancestor.
  
  2. Use the distribution toward the cost of buying, building or rebuilding your first home no longer than 120 days after receiving the funds.
  
  3. Understand that your total qualifying distribution for the home cannot exceed $10,000.
  
  

Taxation

• The IRS taxes qualified or unqualified distributions from your traditional and SIMPLE IRAs at your normal income tax rate--this money is considered additional income and was not taxed at the time of deposit into the fund. Roth IRA contributions are not taxed, because the contributions were taxed at the time of deposit; however, earnings are taxed if withdrawn from a Roth IRA that is less than five years old.
  
  Provided you meet the criteria for a qualified distribution from your IRA for the purchase of your first home, you will not be penalized the 10-percent early distribution tax (as discussed above); you will be taxed income tax on the distribution, however, if taken from your traditional or SIMPLE IRA, and only earnings will be taxed if taken from your Roth before the five-year mark.
  
  

Considerations

• Before you take the money and run, think about how the IRS (depending on the type of IRA you hold) will tax the $10,000 distribution, and determine whether removing the money from your IRA to buy a home is beneficial or detrimental to your actual retirement. If you do decide to fund your first home's down payment with your retirement funds, make sure to pull them from your IRA and not your 401k. Sheyna Steiner writes on Bankrate.com, "though you may take money out of your 401k to use as a down payment, expect to pay a 10 percent penalty." Employer-sponsored plans are not required to allow early withdrawals, and those that do, usually do not permit them for education or housing purposes.