You usually have to wait until you reach age 59 ½ before you can dip into your retirement funds penalty-free. Otherwise, you end up forfeiting 10% of the amount you withdraw from your 401(k) or similar tax-deferred retirement plan. But what if you want to retire sooner than that and need access to your money?
If you are at least 55 years old, you may be in luck, thanks to what is known as the Rule of 55. This IRS provision has saved one retiree “about $24,000 in tax penalties,” and another says they “wouldn’t have been able to retire from teaching early” without it, said The Wall Street Journal. And yet, it remains a “tax break few people know about, and even fewer use.”
What is the Rule of 55?
The Rule of 55 is an “IRS provision that allows you to withdraw money from your 401(k) or other qualified retirement plan without the 10% early withdrawal penalty if you leave your job in or after the year you turn 55,” said Kiplinger. Typically, you pay this penalty on top of the other taxes you owe on withdrawals from tax-deferred retirement accounts, like 401(k) and 401(3)b plans. But if you meet the eligibility requirements, the Rule of 55 lets you skip that early withdrawal penalty, though you will still owe taxes on the amount withdrawn. Note that the rule only applies to employer-sponsored retirement plans; it does not apply to IRAs.
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Who is eligible for the Rule of 55?
Generally, “to qualify, you must leave your job — either voluntarily or involuntarily — in or after the year you turn 55,” said Kiplinger. This timeline gets moved up a bit for “public safety employees, such as police officers, firefighters, EMTs and air traffic controllers,” for whom the rule “applies in the calendar year in which they turn 50,” said Charles Schwab.
Further, you can only withdraw funds penalty-free “from the plan specific to your most recent employer,” meaning the account you were contributing to when you stopped working, said Charles Schwab. The money also needs to stay in that plan for you to continue to access it without penalty, at least until you turn 59 ½. You cannot roll over the funds to an IRA or other retirement account and still make penalty-free withdrawals.
When does it make sense to use the rule for early withdrawals?
The Rule of 55 can make a major difference “if you’ve decided to retire during or after the year in which you attain age 55 and need immediate financial support,” said Fidelity. But it is not necessarily a magic bullet for an early retirement. “Remember, if you’re withdrawing money from your retirement savings, they can no longer benefit from potential compounding returns,” said Charles Schwab.
Generally, the approach tends to make sense either as a bridge to cover short-term needs in the interim, such as in the case of an unexpected late-career layoff, or if you have an ample balance in your 401(k). “If you’ve managed to save well in your current 401(k), you may be able to retire early with enough income to take some withdrawals now and support yourself in your future retirement years,” said Fidelity.
