Retirement Income
February 27, 2023
Hoping to access your 401(k) early? With the rule of 55, you may be able to access and take early withdrawals from your 401(k). Here's what you need to know.
If you've ever invested in a 401(k), 403(b), or similar tax-deferred plan, you likely know you're generally expected to keep the money in the account until you're at least 59 1/2—if you don't want to be stuck with a penalty. However, there is a way around the penalty if you want access to your money a little earlier.
With the rule of 55, you have the potential to begin taking distributions from your 401(k) before you normally could. Here's what you need to know about using the 401(k) rule of 55 to your advantage.
What is the rule of 55?
The IRS rule of 55 recognizes you might leave or lose your job before you reach age 59½. If that happens, you might need to begin taking distributions from your 401(k). Unfortunately, there's usually a 10% penalty—on top of the taxes you owe—when you withdraw money early.
This is where the rule of 55 comes in. If you turn 55 during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty. However, you must still pay taxes on your withdrawals.
Not only does the rule of 55 work with a 401(k), but it also applies to 403(a) and 403(b) plans. If you have a qualified plan, you might be able to take advantage of this rule. You can verify the status of your plan by checking with the Summary Plan Description you received (or can access electronically) for your workplace retirement plan.
5 things to know about the rule of 55
Before you start withdrawing money from your 401(k), it's important to understand five things about the IRS rule of 55.
1. Public safety employees get an extra five years.
Police officers, firefighters, EMTs, and air traffic controllers are considered public safety employees, and they get a little extra time to access their qualified retirement plans. For them, the rule applies in the calendar year in which they turn 50.
Double-check to ensure your plan meets the requirements and consider consulting a professional before withdrawing money.
2. You can withdraw only from the plan specific to the employer.
Before you start taking distributions from multiple retirement plans, it's important to note the 401(k) withdrawal rules for those 55 and older apply only to your employer at the time you leave your job.
In other words, you can only take those penalty-free early 401(k) withdrawals from the plan you were contributing to at the time you left (or were fired from) your job. The money in other retirement plans must remain in place until you reach age 59 1/2 if you want to avoid the penalty.
3. You must leave your job the calendar year you turn 55 or later.
The rule of 55 doesn't apply if you left your job at, say, age 53. You can't start taking distributions from your 401(k) and avoid the early withdrawal penalty once you reach 55. However, you can apply the IRS rule of 55 if you're older and leave your job. If you get laid off or quit your job at age 57, for example, you can start taking withdrawals from the 401(k) you were contributing to at the time you left employment.
4. The balance must stay in the employer's 401(k) while you're taking early withdrawals.
The rule of 55 doesn't apply to individual retirement accounts (IRAs). If you leave your job for any reason and you want access to the 401(k) withdrawal rules for age 55, you need to leave your money in the employer's plan—at least until you turn 59 1/2. You can take withdrawals from the designated 401(k), but once you roll that money into an IRA, you can no longer avoid the penalty. And if you've been contributing to an IRA as well as your 401(k), you can't take penalty-free distributions from your IRA without meeting certain requirements.
5. You can withdraw from your 401(k) even if you get another job.
Finally, you can keep withdrawing from your 401(k), even if you get another job later. Let's say you turn 55 and retire from your work. You decide you need to take penalty-free withdrawals under the rule of 55 and begin to take distributions from that employer's plan. Later, at age 57, you decide you want to get a part-time job. You can still keep taking distributions from your old plan as long as it was the 401(k) you were contributing to when you quit at age 55—and you haven't rolled it over into another plan or IRA.
Should you use the rule of 55?
Even if you're eligible to withdraw money penalty-free from your 401(k) or other qualified retirement plan early, consider it carefully. Just because you can doesn't mean you should. Remember, if you're taking money from your retirement account, it can no longer benefit from (potential) compounding returns. If you retire early, or if you were laid off and you need the distributions to cover living expenses, it could make sense. But if you get another job and cover your costs that way, it might not make sense to begin drawing down your 401(k).
Also, be aware your employer might automatically roll over your 401(k) account to an IRA once your 401(k) balance drops to $5,000 or below. You won't lose this money, but it may end up in an IRA that you did not choose.
Finally, if you made Roth contributions to your 401(k), these withdrawals are usually tax-free, so determine if taking withdrawals from your Roth account in the 401(k) plan makes sense or if you should withdraw from the taxable account.
Review your choices carefully and consider consulting with a retirement specialist to determine what might work for your situation.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner, or investment manager.
The Rule of 55, a provision by the IRS, grants individuals the opportunity to access their 401(k) or similar retirement accounts penalty-free if they leave or lose their job in the calendar year they turn 55 or older. Here's an in-depth analysis covering the various components of this regulation and its implications:
Understanding the Rule of 55:
1. Eligibility and Exceptions:
- Individuals aged 55 or older who leave their job can access their 401(k) without the standard 10% early withdrawal penalty.
- Public safety employees (e.g., police officers, firefighters) have an even earlier withdrawal window, starting at age 50.
2. Employer-Specific Plans:
- The rule applies solely to the retirement plan associated with the employer when leaving the job. Other plans remain subject to penalties until the standard retirement age of 59 1/2.
3. Timeline Considerations:
- To benefit, individuals must leave their job in the calendar year they turn 55 or older. Departing before this age disqualifies them from using this provision.
4. Account Specifics:
- Withdrawals must be made from the employer's 401(k) plan directly. Moving this money into an IRA nullifies the exemption.
5. Continued Withdrawals and Job Changes:
- Even if individuals find another job after turning 55, they can still withdraw from their old 401(k) if they haven't transferred it.
Considerations and Caution:
1. Financial Strategy:
- It's crucial to evaluate the necessity of early withdrawals, as they can impact long-term savings potential due to reduced compounding returns.
- Consider alternative sources of income before resorting to 401(k) withdrawals.
2. Plan Management:
- Be mindful of potential automatic rollovers by employers for low-balance 401(k) accounts. This might lead to the funds ending up in an unintended IRA.
3. Roth Contributions:
- Withdrawals from Roth 401(k) accounts are typically tax-free, offering a strategic advantage compared to taxable accounts.
Additional Tips:
- Consult a retirement specialist or financial advisor to tailor this strategy to individual circ*mstances.
- Evaluate Roth conversions and tax implications for smarter long-term planning.
Conclusion:
While the Rule of 55 offers an appealing opportunity for early access to retirement funds without penalties, its implementation requires careful consideration. Individual financial situations and long-term goals must guide decisions regarding early withdrawals from retirement accounts. Consulting with professionals ensures an informed approach aligned with specific needs and goals.
The article wisely advises seeking personalized advice before making financial decisions, as strategies must align with individual circ*mstances and goals. Always consider the potential tax implications and long-term effects on retirement savings before opting for early withdrawals.
