In this article:
The rule of 55 is an IRS provision that allows certain workers to tap into their 401(k) savings without incurring a penalty after age 55. To use the rule of 55, you'll need to leave or lose your job during the year you turn 55 or later, and you can only use the rule to withdraw from your most recent workplace's plan.
Before you consider using the rule of 55 to retire early, it's important to weigh how drawing on your retirement savings early will impact the overall value of your portfolio and your long-term retirement plan. In general, it's a good idea to let your savings grow as long as you can before you begin to deplete it. Here's what you need to know about the rule of 55, plus other ways you may be able to tap into your 401(k) early.
What Is the Rule of 55?
The rule of 55 is an IRS provision that allows people who meet certain criteria to take early distributions from their 401(k), without paying a penalty.
Ordinarily, withdrawing funds from your 401(k) early results in a 10% early withdrawal penalty. You can begin withdrawing money from your 401(k) without facing the penalty once you reach age 59½.
But the IRS makes a special allowance to help workers who, whether by necessity or choice, retire a few years earlier. The rule of 55 allows you to begin taking penalty-free withdrawals from your 401(k) if you leave or lose your job in the calendar year you turn 55 or later. Keep in mind that you'll still have to pay income taxes on your 401(k) distributions.
The rule of 55 also applies to 403(a) and 403(b) plans. But it doesn't apply to individual retirement accounts (IRAs), including traditional, Roth and rollover accounts. You'll have to wait until age 59½ to access those assets without penalty.
The rule of 55 differs for certain types of workers. For example, if you're a qualified public safety worker through your state or local government, such as an EMT or firefighter, you may be able to take penalty-free early withdrawals from your governmental retirement account starting at age 50.
Pros and Cons of the Rule of 55
Before you consider using the rule of 55 to take early distributions from your 401(k), consider the advantages and disadvantages.
Advantages of the Rule of 55
- You won't face a 10% penalty. The primary benefit of the rule of 55 is that, if you qualify, you can tap into your retirement savings before age 59½ without triggering a penalty.
- You can qualify even if you get a new job. To qualify for early withdrawals through the rule of 55, you need to leave or lose your job no earlier than the year you turn 55. But you can continue to take those distributions even if you get a new job. So, if you start taking distributions now, then decide you can work part time down the road, you won't have to worry about penalties.
- Early withdrawals can lower required minimum distributions (RMDs). If you have a sizable nest egg stashed in your 401(k) account, taking RMDs after age 72 may feel burdensome. You'll need to withdraw a certain portion of your funds each year in order to avoid hefty penalties, and you'll have to pay taxes on the money you withdraw. By taking distributions early through the rule of 55, you can spread out your distributions and lower the eventual amount you'll be required to withdraw each year, which could potentially also lower your taxes.
Disadvantages of the Rule of 55
- The rule only applies to your most recent employer. Whether you quit your job, are fired or are let go, the rule of 55 allows you to take distributions without paying the IRS penalty. But the rule only applies to your current workplace 401(k), 403(a) or 403(b) plan; you can't use it to access funds from previous employers' 401(k) plans without penalty.
- Early withdrawals eat into your savings. One of the most important considerations when it comes to tapping into your retirement savings early is that you're missing out on the gains you may have earned on your investments if you'd left them to grow longer. This can decrease the overall value of your portfolio.
- You won't have Social Security yet. Generally, you can begin to collect Social Security payments starting at age 62. If you use the rule of 55 to retire years before that, you'll be relying more on your savings each year. That can deplete your reserves faster.
How to Use the Rule of 55 to Retire Early
You may be able to use the rule of 55 to retire early, but you'll need to understand the criteria and key steps before you do.
1. Leave Your Job at Age 55 or Later
To qualify to take early withdrawals from your retirement account using the rule of 55, you'll need to leave your job the year you turn 55 years old or or later. To meet the IRS requirements, you can't leave your job before age 55 and then begin to take distributions once you reach the qualifying year.
2. Withdraw From Your Current 401(k) Only
The rule of 55 only allows you to take penalty-free early withdrawals from the 401(k), 403(a) or 403(b) plan you invested in at your most recent job. In other words, you can only use the rule of 55 to pull from the plan at the job you've left or lost in the year you turn 55 or later. If you have funds invested in other employer-sponsored retirement accounts or in an IRA, you'll still need to wait until age 59½ or later to access those funds without incurring the penalty.
There's a way around this, however: You could roll over the funds from your former 401(k) into your current 401(k). Note that the process can be complicated, and not all employers accept rollovers. Before initiating a transfer, talk to your human resources representative and consult with a tax advisor to avoid unnecessary headaches. If you are allowed to make the transfer, all the funds in your current 401(k), including the transferred amount, will be available if you take early distribution using the Rule of 55.
3. Work With a Financial Advisor
It's always a good idea to check in with a financial advisor before you make changes to your retirement plan.
Planning for retirement is made up of many moving parts, with considerations including market conditions, life expectancy, dependents and more playing a part. And drawing on your funds early can increase the risk of something called longevity risk: the chance that your retirement savings won't last your full lifetime.
A financial advisor can help you better weigh your options to determine if tapping into your 401(k) is really your best option. If you do decide to go this route, your advisor can help you strategize how much to withdraw each year to support yourself, plus how to keep your tax obligation as low as possible.
Other 401(k) Early Withdrawal Exceptions
Beyond the rule of 55, there are other scenarios in which you can take early distributions from your 401(k) without paying early withdrawal penalties.
The IRS makes exceptions for early withdrawals done due to financial hardship, or a heavy and immediate financial need. Depending on your individual plan's policies, reasons you may qualify for a hardship distribution could include:
- You're facing medical expenses.
- You're at immediate risk of foreclosure.
- You're paying for burial or funeral expenses.
- You experience permanent disability.
- You're the victim of a qualified natural disaster.
The Bottom Line
If you're age 55 or older, you may be able to qualify for penalty-free distributions from your 401(k), 403(a) or 403(b) using the rule of 55. But that doesn't necessarily mean it's the best option. Depending on the specifics of your situation, it may be in your favor to hold off on withdrawals and allow your money to keep growing.
For help with retirement planning and evaluating your options for when to take 401(k) distributions, reach out to a financial advisor. A financial advisor can help you devise a plan for creating a steady stream of income in retirement. They can also help you run the numbers to understand the implications of retiring early on your personal retirement outlook.