Using the Rule of 55.
How to Withdraw early from your 401(k)
Without any penalties.
Photo from Pexels
Just about everybody knows if you withdraw from your 401(k) before 59 1/2 – you are going to have to pay taxes plus pay a hefty 10% penalty. What if we told you that you can retire at 55 and not pay the 10% penalty? Our financial planners told us a little known secret to withdrawing early from your current 401(k) without any penalties. This secret is called the Rule of 55 (also known as IRS Publication 575). You can retire early at the age of 55 – and withdraw from your previous employer’s 401(k) without taking any penalties.
Our first reaction here was “What? This sounds too good to be true!”. Well it is true, if you meet certain qualifications.
How the Rule of 55 works
The Rule of 55 allows an employee who retires, quits, or is fired at age 55 to withdraw from their 401(k) without penalties. The 401(k) you withdraw from must be from your “last employer” – not a previous employer 2 or more jobs ago. The Rule of 55 only applies to funds withdrawn from a 401(k). If you retire and roll your 401(k) into an IRA, then we are sorry, rule no longer applies. This applies if you leave your job at any time during the calendar year in which you turn 55 or later.
It’s important to remember the Rule of 55 depends on the year that you leave the company you’re working for, not the year you take a distribution. We will give you three examples showing how some people qualify and some do not.
Ellen loses her job right before her birthday
Ellen is 54 years old and turns 55 on July 15. Her employer lets her go during the same year – 2 months before her birthday – on May 15th. All of Ellen’s retirement money is in her 401(k) with her current employer.
Ellen would qualify for the Rule of 55 because she turns 55 the same calendar year that she lost her job – and also her 401(k) is with her current employer.
Bob leaves his job voluntarily and has multiple 401(k)s
Bob is 54 years old and turns 55 on September 20th. He has lots of money in several 401(k)s from his previous employers. He decides to leave work on September 1st.
Bob qualifies for the Rule of 55 because he is leaving the same year he turns 55. However, he will only be able to take money out of his current 401(k) without a 10% penalty. The Rule of 55 only applies to 401(k)s from a current employer. Bob could have avoided this if he had rolled all of 401(k)s into his current employer first before he left his job.
Barb is downsized at age 54 and waits till 55 to withdraw
Barb is 54 years old and her birthday is on February 15th. Her employer unfortunately went through some downsizing and let her go on July 7th. Barb wants to wait till she is 55 till she withdraws money from her 401(k).
Barb does not qualify for the Rule of 55 because she does not turn 55 the same calendar year that she lost her job.
What to do next
Talk to your financial planner
Do not make your retirement choices from what you have read off the the internet. It is essential that you have a certified financial adviser and a tax consultant working for you. They can help you with all of the rules if you wish to retire early. Ask them about the Rule of 55. You may want to consider rolling all of your 401(k)s into your current employer before you leave. If you roll everything into an IRA – you will not be able to use the Rule of 55. Remember – the Rule of 55 only applies to a 401(k) from your previous employer.
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