The Rule of 55

What Is the Rule of 55?

The rule of 55 is an Internal Revenue Service (IRS) rule that allows workers who are 55 or older to withdraw money from their employer-sponsored retirement accounts penalty free if they leave their jobs. This rule effectively allows older workers who separate from their employers to access retirement savings early, without being subject to a 10% early withdrawal penalty.

The rule of 55 applies specifically to workplace plans, including 401(k) plans and 403(b) plans. It does not extend to individual retirement accounts (IRAs).

Key Takeaways

  • The rule of 55 is an IRS rule that allows certain workers to avoid the 10% early withdrawal penalty when taking money out of workplace retirement plans before age 59½.
  • To qualify for the rule of 55, withdrawals must be made in the year that an employee turns 55 (or older) and leaves their employer, either to retire early or for any other reason.
  • The rule of 55 only applies to workplace plans. What's more, plans are not required to include the provision.
  • Retirement plan distributions taken using the rule of 55 would still be subject to ordinary income tax.

Understanding the Rule of 55

Workplace retirement plans are designed to help workers save for their twilight years. Ordinarily, you can’t withdraw money from these plans before age 59½ without facing a 10% early withdrawal penalty. This rule is only waived when certain exceptions apply and the rule of 55 is one of them. IRS guidelines allow workers to pull money from their 401(k) or 403(b) plan early without a penalty if both of the following are true:

  • Withdrawals occur in the year the worker turns 55 or later
  • Withdrawals occur after leaving your employer

For example, say that just after your 55th birthday, your company decides to downsize and eliminates your position. The rule of 55 would allow you to take money from your 401(k) or 403(b) without having to pay the 10% early withdrawal penalty.

However, you don’t have to be downsized or fired to apply the rule of 55. You could also take advantage of it if you decide to retire early or simply want to change jobs later in your career.

The rule of 55 can only be used with the 401(k) or 403(b) plan you have with your current employer; it does not apply to any retirement accounts you still have with former employers.

The Rule of 55 vs. a 401(k) Loan

The rule of 55 only applies in situations in which you leave your employer. If you’re still working for the same company that holds your current 401(k), you can’t use it. You could, however, take out a 401(k) loan if your plan allows it.

The IRS allows workers to borrow up to 50% of their vested account balance or $50,000, whichever is less. This money is paid back over a period of five years through salary deferrals, typically at a low interest rate. Whether you can continue making new contributions to your 401(k) during this time will depend on the plan.

The catch is that if you leave your employer, any remaining balance due on the loan becomes payable immediately. If you’re unable to pay back the loan in full, the entire amount becomes a taxable distribution, meaning that you would owe income tax on the amount you borrowed, along with the 10% early withdrawal penalty if you're under age 59½.

It’s possible to avoid the tax penalty on 401(k) loan distributions by rolling over the outstanding balance to an IRA.

An Alternative: Substantially Equal Periodic Payments (SEPPs)

The rule of 55 can be used to plan early withdrawals from a 401(k) or 403(b), but it isn’t the only option for avoiding the 10% penalty. You could also take money from a workplace retirement plan before age 59½ using substantially equal periodic payments (SEPPs). This option can be found under IRS rule 72(t).

The rule allows workers to take a series of payments from their retirement plan for five consecutive years before turning 59½ years old. These payments are based on your life expectancy. They can be taken annually or monthly and the 10% early withdrawal penalty does not apply.

Taking SEPPs may be preferable if you’d like to access your retirement savings early but don’t anticipate leaving your job in the year you turn 55 or later. You don’t have to wait until you’re 55 to begin receiving these payments, so there is some additional flexibility. Still, keep in mind that any time you take money from your 401(k) or 403(b) early, you’re limiting your account’s potential for future growth.

The rule of 55 actually kicks in at 50 for public safety employees in federal, state, and local governments. These would include police, firefighters, air traffic controllers, customs and border protection officers, FBI agents, and medical service workers.

Other Exceptions to the 401(k) Early Withdrawal Penalty

In addition to the rule of 55, the IRS does allow for other exceptions to the 10% early withdrawal penalty. Generally, you can avoid the penalty if early withdrawals are made for any of the following reasons:

Penalties, though not income tax, may also be waived for 401(k) hardship withdrawals if your plan allows them.

What Is the Rule of 55?

The rule of 55 is an IRS policy that allows workers to take early withdrawals from their employer-sponsored retirement accounts, such as 401(k)s and 403(b)s, at age 55 or older without paying a 10% penalty provided that they leave their jobs. It only applies to accounts you have with your current employer. Older accounts with former employers would not be eligible.

Does the Rule of 55 Waive Taxes on the Distributions?

No. You still pay taxes on the money because contributions were made with pretax funds.

What Are Substantially Equal Periodic Payments (SEPPs)?

SEPPs are an alternative to using the rule of 55 if you want to make early withdrawals from your retirement accounts without penalty. Before you reach age 59½, you are allowed to take substantially equal withdrawals from your retirement accounts for five consecutive years on an annual or monthly basis. The amount is based on your life expectancy.

Can I Use the Rule of 55 if I Get Another Job?

The rule of 55 allows you to withdraw money penalty free from your most recent employer’s 401(k) after you leave that job. If you’ve already begun taking penalty-free withdrawals from your former employer’s plan, there’s nothing preventing you from taking another job later. You could also contribute to your new employer’s workplace retirement plan to continue to grow your savings.

Can I Retire at 55 and Collect Social Security?

No. The earliest you can receive Social Security retirement benefits is age 62, so you cannot retire at 55 and start collecting Social Security that same year. You’d have to wait until you turn 62 to take benefits, which would be reduced, as you would be taking them before full retirement age, which is 66 or 67 for most people.

The Bottom Line

The rule of 55 could make early retirement less taxing financially, as you could tap into your 401(k) without early withdrawal penalties. Whether it makes sense to take advantage of this rule can depend on whether you plan to return to work later, as well as how much money you have saved and invested for retirement outside of your employer’s plan. Creating a diversified portfolio that includes a 401(k), an IRA, and a brokerage account can help you to manage the various tax implications of retiring early.

Article Sources
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  1. Internal Revenue Service. "Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other Than IRAs."

  2. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions."

  3. Internal Revenue Service. "Retirement Topics - Plan Loans."

  4. Internal Revenue Service. "Substantially Equal Periodic Payments."

  5. Cornell University Legal Information Institute. "Qualified Public Safety Employee."

  6. Internal Revenue Service. "Retirement Topics - Hardship Distributions."

  7. U.S. Social Security Administration. "Starting Your Retirement Benefits Early."

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