What Is the Rule of 55?

Workplace retirement plans like 401(k)s and 403(b)s are often a significant piece of someone’s post-working income strategy. Normally, you must be 59½ years old before you can start withdrawing funds from these types of accounts. And, if you take money out earlier than this, you’ll incur a costly 10% tax penalty.

But what if you would like to leave your job and begin your retirement a little earlier? This is where the rule of 55, an exception to typical early withdrawal rules, comes to the rescue. This article will explain the concept, highlight who should use it, and discuss some of its pros and cons, including how it can impact your holistic plans.

Understanding the Rule of 55

The usual age to begin withdrawing savings from your 401(k) or 403(b) is 59½ years old. As mentioned, doing so before this comes with a heavy 10% tax. The rule of 55 is one of many Internal Revenue Service (IRS) withdrawal exceptions for defined contribution retirement plans, such as 401(k)s and 403(b)s. It allows you to begin taking early withdrawals penalty-free from your workplace plan if you leave your job at age 55 or older, whether you retire, resign, or were let go.

As part of the exception, the IRS notes that if you’re a “public safety employee,” such as a firefighter or police officer, you may start withdrawing funds after leaving your job beginning at age 50.

It’s also crucial to note that even though the rule allows you to withdraw your money free from penalty, traditional accounts are still subject to income tax. This is because these accounts are tax-deferred, meaning that you put off tax payments until you reach the age to withdraw.

Eligibility Requirements

The rule of 55 only extends to qualified retirement plans, including 401(k)s for private sector employees and 403(b)s for various public sector employees. It also only works with your plan from your most recent job. Therefore, if you had a job with a retirement plan before the one you left when you turned 55, you won’t be able to take funds out of that until you reach 59½.

“It’s important to understand that this provision applies only to withdrawals from 401(k) plans, so individuals with IRAs or other retirement accounts may not be eligible,” explains Paul Miller, Managing Partner and CPA at Miller & Company, LLP in New York City. “Before proceeding with early withdrawal, retirees should verify their eligibility and consult with a financial advisor,” he continues.

To recap, qualifying for the rule of 55 requires you to:

• Have a 401(k) or 403(b) through your employer.
• Leave your job at age 55 or later (or 50 for public safety employees).

Who Should Use the Rule of 55?

The rule of 55 is for people who leave their job early either out of desire or necessity and want to begin drawing an income from their retirement plan early. This can be effective if you’ve been planning and now have the means to retire early.

For example, consider that you’ve been saving and investing your money well for much of your career. Then, after talking to a financial advisor and reflecting on the point in your career, you feel that it’s the right time to retire. In this case, the early withdrawal exception can allow you to begin drawing an income before you gain access to other retirement accounts, such as IRAs and Roth IRAs, and social security.

Miller emphasizes that the “flexibility” that the rule of 55 affords “can be crucial for those needing access to retirement savings before reaching age 59½.” He also notes that “[d]eciding whether to use the Rule of 55 depends on individual financial circumstances and retirement plans,” but that “[i]t can be particularly useful for those planning to retire early and needing access to retirement funds to cover expenses before reaching age 59½.”

Are There Any Disadvantages?

As mentioned, the rule of 55 can be a powerful tool if you decide it’s the right time to retire early. Specifically, this is because it enables you to have an income if you aren’t working but aren’t quite ready to retire. Or, in other cases, it also lets you start an early retirement before getting income from other sources, such as social security. The rule, however, can have some drawbacks you should keep in mind.

One disadvantage, for instance, is that the temptation of access to the money may cause you to withdraw ahead of when you planned. Unfortunately, while this can help in the short term, it could have adverse effects on your future retirement strategy. “Withdrawing funds early can reduce the amount of money available for later years of retirement, potentially impacting long-term financial security,” Miller says.

Another important disadvantage is that withdrawing early using the rule of 55 may impede growth. While in your workplace plan, your money can grow via compound interest and investments. If you begin moving money to, say, a savings account, you won’t be able to see the same growth.

A final element to consider is that even though you avoid a penalty, you must still pay income tax on any withdrawals you make. Moreover, you might be in a higher tax bracket than you would if you began taking funds out later. Per Miller, this “may result in higher tax burdens in the year of withdrawal.” Therefore, he recommends that “retirees should carefully evaluate the implications before proceeding with early withdrawal under the Rule of 55.”

Frequently Asked Questions

Does the rule of 55 apply to IRAs?

No, the rule of 55 doesn’t apply to IRAs, including Roth, SEP, and SIMPLE accounts. It only works for qualified workplace retirement plans, such as 401(k)s and 403(b)s. IRAs and their sub-types, however, have different early withdrawal exceptions. We recommend consulting the IRS website for a full list of them, as well as talking with a financial advisor or retirement planning professional if you have any questions.

What are the advantages of the rule of 55?

The rule of 55 has many specific pros, especially for those who are looking to retire early or are unemployed in their later working years. Below is a list of its notable advantages:

• Allows you to withdraw money penalty-free.
• Can enable you to retire early.
• Can let you live off retirement account income temporarily until you get a new job.

Can you continue taking early withdrawals if you get another job?

If you leave one employer at 55 or older and would like to continue working somewhere else, you can still take early withdrawals from your previous job’s 401(k) or 403(b). This can be an effective way to maximize income from two sources before you fully retire.