10 Reasons Why People Cash Out IRAs Early

Buying a First Home
You can tap your IRA funds to buy your dream house penalty-free. dagmar heymans/E+/Getty Images

Buying a home is the culmination of the American dream, but the costs can add up. Even if you can scrape together 20 percent to cover the down payment, there are closing costs, mortgage insurance and other fees that can add thousands to your bill. It's tempting to tap your IRA in order to close on a dream home. But is that a good idea?

First, the good news. The IRS waives the 10 percent early withdrawal penalty for first-time homebuyers. That means you can withdraw up to $10,000 from either a traditional or Roth IRA before age 59 ½ without the extra 10 percent tax. Even better, your spouse can withdraw the same amount penalty-free [source: IRS]. The IRS is very generous with its definition of a "first-time" homebuyer. As long as you haven't owned a home in the past two years, you're good [source: IRS].

Now, the fine print. You need to use that $10,000 to pay for the buying, building or rebuilding of a home within 120 days of withdrawing the funds, or else you will be smacked with the 10 percent penalty. But if the 120-day deadline is looming, and your home purchase or construction was canceled or delayed, you can roll the funds back into your IRA penalty-free [source: IRS].

And remember, just because you avoid the penalty doesn't mean you avoid taxes entirely. You still have to follow the income tax rules for early withdrawal of the two types of IRAs.