If you’re looking to retire in your mid 50’s and want to be able access your retirement nest egg, then I’ve got some good news for you: The 401(k) Age 55 Rule might allow you to accomplish your goal of early retirement!
As most people in the U.S. know, when it comes to retirement planning, the IRS says you have to wait until at least age 59-1/2 to start withdrawing funds from any tax-deferred retirement accounts such as your 401(k) or IRA.
Otherwise, you’ll have to pay a pesky 10% penalty along with any applicable taxes.
If you’re an early retirement seeker like, then this creates a big problem.
How are you supposed to be able to access all the money you’ve saved for decades to be able to start your retirement and finally enjoy the fruits of your labor?
Fortunately, there is one small, little-known exception in the rules for 401(k) plans.
It’s called the 401(k) Age 55 Rule, and it basically allows you to start making penalty-free withdraws from your retirement nest egg as soon as the year you turn age 55.
Here’s everything you need to know.
How the 401(k) Age 55 Rule Works
The 401(k) Age 55 Rule comes from IRS Publication 575, and it says the following:
The following additional exceptions apply only to distributions from a qualified retirement plan other than an IRA: Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55.
In other words, under normal conditions, you don’t have to pay the 10% penalty as long as you leave your job on or after the year you turn 55. Not before.
The other major component is actually separating from your job. This rule does not work if you’re still employed. The term “separation” can mean many things. You could leave by your own will (retire), be laid off, or fired.
Example 1: You leave your job at age 56. Under the Age 55 Rule, you can start withdrawing from your 401(k) plan without fear of the 10% penalty.
Example 2: You get laid off from your job at age 54 and don’t turn 55 until next year. Under the Age 55 Rule, you are too young to qualify. Therefore, you’d have to pay the 10% penalty.
Example 3: You get fired from your job at age 54 but turn 55 in just a few months. Under the Age 55 Rule, you can start withdrawing from your 401(k) plan without fear of the 10% penalty.
Which Retirement Plans Apply?
Although this rule is often most associated with 401(k) plans, we should clarify that it actually applies to all “qualified retirement plans”. In general, this would be either a 401(k) or 403(b) employer sponsored plan.
Also keep in mind that this rule only applies to traditional-style retirement plans (no taxes now, pay taxes at retirement). For those people who love Roth-style plans (pay taxes now, no taxes at retirement), these ones do not qualify because the rules associated with Roth’s are different. With a Roth, contributions are available anytime for withdrawal. Only the earnings have to wait until age 59-1/2.
If you happen to work in a government institution that offers a 457 plan, these plans don’t qualify either. But there’s a good reason why. 457 plans aren’t subject to the additional 10% penalty tax to begin with. Participants of this type of retirement plan can start taking withdrawals anytime they wish, and only need to pay the taxes associated with those withdrawals.
Unfortunately this rule does not extend to IRA’s. When it comes to an IRA, you simply have to wait until age 59-1/2 unless you meet one of the other special requirements. OR you could use one of the other special early withdrawal techniques like a 72(t) rule / SEPP or a Roth IRA Conversion Ladder.
Check Your Employer’s Rules
Unfortunately, even though the IRS may allow you to start receiving benefits by age 55, your employer might not. This could even be the case after you’ve separated from service.
One very important caveat about employer sponsored plans such as 401(k)’s is that the rules are dictated by your employer. Yes, the money is yours. But the specific rules for how and when you can access it is not always the same. Since your employer dictates the plan, they can often place their own rules on top of the IRS rules. The only way to know for sure is to read your provider’s Summary Plan Description or have a nice talk with your Human Resources department at work.
If HR does deny you early access to your 401(k) at age 55, you could always gain that control back by rolling over your savings to an IRA. From there, you’d want to use the 72(t) rule / SEPP or a Roth IRA Conversion Ladder like we mentioned above. Although you wouldn’t have the ability to withdraw the money as freely as you could with the 401(k) at age 55, it does at least let you gain some access to your nest egg.
Featured image courtesy of Unsplash