The Rule Of 55

What Is The Rule Of 55?

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Do you want to retire at 55? One strategy to retire early that is gaining popularity is the Rule of 55. While you usually can’t access retirement funds before 59 ½ without paying the 10% early withdrawal penalty, the IRS has made one exception. The Rule of 55 allows individuals to access and take early withdrawals from their 401(k) or 403(b) at 55. In this guide, we’ll explore the Rule of 55 and show you how to leverage it to achieve your early retirement goals.

What is the Rule of 55?

The Rule of 55, also known as the 55 Rule or 55/401(k) Rule, is a provision that allows individuals who separate from their employer in the year they turn 55 (or later) to withdraw funds from their employer-sponsored retirement plan, such as a 401(k) or 403(b) plan, without incurring the usual 10% early withdrawal penalty. Any distributions are still subject to income tax. 

This rule can benefit individuals with an employer-sponsored retirement account who want to retire at 55. This provision can also be a valuable resource for workers needing cash flow later in their careers.

If you have a retirement plan through your employer, there’s a possibility you can leverage this rule. You can confirm your eligibility to utilize this exception by reviewing the ‘Summary Plan Description’ provided to you for your workplace retirement plan.

How much can you withdraw using the Rule of 55?

There is no limit to the amount that can be withdrawn from a qualified plan under the rule of 55. However, the rules for each plan are different. It’s crucial to verify the process and details of making early withdrawals under the Rule of 55 directly with the administrator of your retirement plan.

Seven things you need to know about the Rule of 55

1. You can withdraw only from the plan specific to the employer.
Under the Rule of 55, you can only make penalty-free withdrawals from the retirement plan you contributed to when you retired from your job. Other retirement accounts, such as an older 401(k) or a traditional or Roth IRA, aren’t eligible for this exception, and any funds must remain untouched until you reach 59 ½.

2.  You must leave your job the year you turn 55 or later.
The rule of 55 doesn’t apply if you leave your job any earlier than age 55. However, if you are older and decide to quit your job, you can utilize the IRS Rule of 55. For instance, if you are laid off or resign at age 57, you can begin withdrawing funds from the 401(k) you contributed to during your employment departure.

If you plan to retire early and take advantage of this provision, ensure your employment separation aligns with this requirement.

3. The balance must remain in the employer’s 401(k) while you make early withdrawals.
While taking early withdrawals under the Rule of 55, the remaining balance in your employer’s 401(k) plan must stay intact. If you transfer or roll over the funds to another retirement account, such as an IRA, you will lose the rule of 55 penalty protection.

4. The distributions are not completely tax-free
While the Rule of 55 allows individuals to make penalty-free withdrawals from their employer-sponsored retirement plans like a 401(k) or 403(b) starting at age 55, these withdrawals are still subject to ordinary income tax. Only the 10% tax penalty is bypassed in this scenario. Understanding the tax implications of using the Rule of 55 for early retirement withdrawals.

5. Public safety employees might be able to start five years early
Qualified public safety employees, such as firefighters, law enforcement officers, and emergency medical technicians, can typically start penalty-free withdrawals at age 50. This provides an additional five years of flexibility compared to the standard Rule of 55.

6. You can still withdraw early even if you get another job.
Unlike some retirement withdrawal rules, the Rule of 55 allows you to withdraw from your employer’s 401(k) plan even if you secure another job after retiring early. You can continue working in a new job while accessing funds from your previous employer’s retirement plan without penalties.

7. If you think you will use the Rule Of 55 to retire early, roll all of your retirement plans into your current plan so that you can access those funds as well.
You can transfer funds from IRA plans you wish to access early into your current employer-sponsored retirement plan while still employed. This allows you to potentially access these funds through your current plan’s provisions.

Steps to Retire Early Using the Rule of 55

Step 1: Assess your financial situation
Before planning your early retirement, evaluate your current financial situation. Calculate your savings, investments, and expected retirement expenses. Consulting with a fiduciary financial advisor is crucial at this stage, as they can evaluate your financial situation and provide tailored recommendations to help you achieve your future financial objectives.

Step 2: Understand eligibility requirements
To use the Rule of 55, you must meet specific criteria:

  • Be at least 55 years old in the year you leave your job.
  • Have funds in an employer-sponsored retirement plan like a 401(k) or 403(b).

Step 3: Plan your exit strategy
Plan your retirement carefully to maximize the benefits of the Rule of 55. Consider negotiating your retirement date to align with turning 55 in the same calendar year to qualify for this provision.

Step 4: Know your withdrawal options
Once retired, explore your withdrawal options under the Rule of 55. Understand the tax implications and decide on a withdrawal strategy that suits your financial needs and goals. 

>> Do you want to retire by 55? Join our exclusive 7-week educational series to make that dream a reality. 

What are the advantages of retiring at 55 with the rule of 55?

There are many advantages to retiring at 55 with the rule of 55, including;

  • Penalty-free withdrawals: One of the primary benefits of the Rule of 55 is the ability to make withdrawals from your employer-sponsored retirement plan (e.g., 401(k)) without incurring the usual 10% early withdrawal penalty that typically applies to withdrawals made before age 59½.
  • Early access to retirement funds: Retiring early with the Rule of 55 provides access to your retirement savings earlier, allowing you to fund your early retirement lifestyle and cover expenses without waiting until the traditional retirement age.
  • Transition to a second career or part-time work: Early retirement with the Rule of 55 can enable individuals to transition to a second career, start a new business, or work part-time in a less demanding role.
  • Reduced stress and improved health: Retiring early may minimize stress associated with full-time job demands, potentially resulting in improved overall health and well-being.
  • Lower tax bracket: During early retirement, individuals may be in a lower tax bracket than their peak earning years. This can result in tax savings when withdrawing funds from retirement accounts, including those accessed under the Rule of 55.
  • Time for personal pursuits: Early retirement gives individuals more time to pursue personal interests, hobbies, and passions that may have been neglected during their working years.
  • Ability to enjoy retirement while active: Retiring early allows individuals to enjoy their retirement years while still relatively active and healthy.
  • Family and leisure time: Early retirees can spend more quality time with family and loved ones.

What are the pitfalls of the rule of 55?

While retiring at 55 with the rule of 55 is appealing, there are many pitfalls that you need to be aware of, including;

  • Limited to employer-sponsored plans: The Rule of 55 applies specifically to employer-sponsored retirement plans like 401(k) or 403(b). If your retirement savings are not held in these plans, you won’t qualify for penalty-free withdrawals under this rule.
  • Tax implications: While withdrawals under the Rule of 55 avoid the early withdrawal penalty (typically 10% for withdrawals before age 59½), they are still subject to income tax. Depending on your tax bracket and the amount withdrawn, this could result in a significant tax liability in the year of withdrawal.
  • Impact on retirement savings: Early withdrawals using the Rule of 55 can diminish your retirement savings potential. By withdrawing funds earlier than planned, you may have less money available to support your retirement needs in the future.
  • No access to IRA funds: Unlike other early withdrawal exceptions, the Rule of 55 does not apply to IRAs.
  • Future tax rates and regulations: Tax laws and regulations are subject to change over time. Withdrawal strategies based on current tax rules may not be advantageous if tax rates or regulations are modified.

Who is the Rule of 55 best suited for?

The Rule of 55 is particularly advantageous for individuals in specific situations, including:

  • Individuals in their mid-50s who have already reached their financial retirement goals and want to retire at 55. 
  • Individuals who want to transition to a new career or start a business can use the Rule of 55 to bridge financial gaps during the transition period.
  • Individuals facing health issues or disabilities that limit their ability to work.
  • Individuals who are unexpectedly laid off in their mid-50s.

Should you use the Rule of 55?

Even if you qualify for penalty-free early withdrawals from your 401(k) or another qualified retirement plan under the Rule of 55, it’s essential to carefully evaluate your options before deciding. Just because you can access your funds early doesn’t automatically make it the most advantageous choice. Your decision will depend on your financial circumstances.

Remember that withdrawing funds from your retirement account means forfeiting the potential for future compounding returns on those funds.

Some situations where it might not be worth taking early withdrawals include:
1) If you have to take a lump sum withdrawal.
If your retirement plan requires a lump sum withdrawal, you may receive more money than needed. This can result in a higher tax liability as the entire amount will be subject to ordinary income tax for that year. Additionally, you will lose the benefit of potential compounding returns on the withdrawn amount.

2) If it pushes you into a higher tax bracket.
A large withdrawal from your retirement plan could push your total annual income into a higher tax bracket. This can result in a higher marginal tax rate and increase your overall tax burden.

It’s best to consult a fiduciary financial advisor before proceeding with early withdrawals under the Rule of 55. 

Do financial planners recommend the rule of 55?

For clients retiring at 55, top-caliber financial planners may recommend delaying the Rule of 55 to take advantage of an increasingly powerful tactic: strategic Roth conversions. 

For example, at 55, Sarah has saved $200,000 in a taxable brokerage account, $500,000 in a pre-tax 401(k), and $800,000 in a Roth 401(k). Upon retiring at 55, Sarah can first withdraw $100,000 a year for two years from her taxable brokerage account to finance her living expenses. 

During those two years, she can strategically conveƒrt part of her pre-tax 401(k) into a Roth IRA to fill the 10% or 15% tax bracket. Sarah can save tens of thousands of dollars in taxes because she will pay taxes on those conversions at a very low tax rate, and the money will grow tax-free inside a Roth.

Once Sarah’s brokerage account runs out, say at 57, she can take advantage of the Rule of 55 and finance her living expenses from her most recent 401(k).

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The Rule Of 55 FAQs 

When was the Rule of 55 enacted?

The Rule of 55 was enacted in 1988 as part of the Technical and Miscellaneous Revenue Act. This act introduced amendments to the tax code of 1968, including provisions related to retirement plans and early withdrawals. It was implemented to provide flexibility and financial options for individuals approaching retirement age.

Does the Rule of 55 apply in every state?

Yes, the Rule of 55 applies to every state. The IRS governs retirement plan regulations.

Can the rule of 55 avoid 401(k) penalties?

Utilizing the rule of 55 means you don’t have to pay the usual 10% early withdrawal penalty. However, you will still be subject to federal and state income tax on your early withdrawals. 

What are other ways to avoid the 401(k) early withdrawal penalty?

Here are some additional ways to avoid the 401(k) penalty

  • Total and permanent disability
  • Qualified higher education expenses
  • First-time home purchase (up to $10,000)
  • Medical expenses that exceed 7.5% of your adjusted gross income
  • Withdrawals made because of an IRS levy plan
  • Qualified disaster distributions
  • Military reservists called to active duty

Does the Rule of 55 waive taxes on the distributions?

No. Taxes still apply to the money withdrawn because contributions were made using pretax funds.

Does the rule of 55 apply to IRAs?

No. You can access only the 401(k) or 403(b) plan sponsored by the employer you just left. You may not access any other tax-advantaged retirement accounts, including 401(k)s that still reside with former employers or IRAs.

If you need to withdraw from your IRA early, you may want to utilize the Substantially Equal Periodic Payments (SEPP) under IRS Rule 72(t).

How much should I have in my 401(k) at 55?

Determining how much you should have in your 401(k) by age 55 depends on various factors, including your retirement goals, lifestyle expectations, anticipated expenses, and desired retirement age. 

We generally want our clients retiring at 55 to have about $2 million across their 401(k), IRA, and taxable accounts. This is so they can have enough money to travel, dine out, pay for costly long-term care expenses, and cover potentially reduced social security benefits.

Is the Rule of 55 the same as Rule 72(t)?

No, the Rule of 55 isn’t the same as Rule 72(t). While both rules pertain to early withdrawals from retirement accounts, they are distinct provisions governed by different tax code sections.

The key differences include:
Type of account: The Rule of 55 applies only to employer-sponsored retirement plans, while Rule 72(t) applies to a broader range of retirement accounts, including IRAs.
– Age requirement: The Rule of 55 allows penalty-free withdrawals for specific employment-related separations at age 55 or older. Rule 72(t) allows penalty-free withdrawals based on specified distribution methods and timing.
– Withdrawal method: The Rule of 55 allows a one-time withdrawal or series of withdrawals from an employer-sponsored plan. Rule 72(t) requires taking substantially equal periodic payments over a specified period.

Retire early with the rule of 55

Retiring early is achievable with careful planning and leveraging strategies like the Rule of 55. Assess your financial readiness, understand the rules, and explore alternative retirement options before deciding if this is the right approach for you. By taking proactive steps, you can work towards enjoying a fulfilling and financially secure early retirement.

If you want to retire by 55 and want a comprehensive financial plan, schedule a free discovery call with one of our fee-only financial planners today.

Common FAQs about the Rule Of 55

The Rule of 55 was enacted in 1988 as part of the Technical and Miscellaneous Revenue Act. This act introduced amendments to the tax code of 1968, including provisions related to retirement plans and early withdrawals. It was implemented to provide flexibility and financial options for individuals approaching retirement age.

Yes, the Rule of 55 applies to every state. The IRS governs retirement plan regulations.

Utilizing the Rule of 55 means you don’t have to pay the usual 10% early withdrawal penalty. However, you will still be subject to federal and state income tax on your early withdrawals.

Here are some additional ways to avoid the 401(k) penalty. 

  • Total and permanent disability
  • Qualified higher education expenses
  • First-time home purchase (up to $10,000)
  • Medical expenses that exceed 7.5% of your adjusted gross income
  • Withdrawals made because of an IRS levy plan
  • Qualified disaster distributions
  • Military reservists called to active duty

No. Taxes still apply to the money withdrawn because contributions were made using pretax funds.

No. You can access only the 401(k) or 403(b) plan sponsored by the employer you just left. You may not access any other tax-advantaged retirement accounts, including 401(k)s that still reside with former employers or IRAs.

If you need to withdraw from your IRA early, you may want to utilize the Substantially Equal Periodic Payments (SEPP) under IRS Rule 72(t).

Determining how much you should have in your 401(k) by age 55 depends on various factors, including your retirement goals, lifestyle expectations, anticipated expenses, and desired retirement age. 

We generally want our clients retiring at 55 to have about $2 million across their 401(k), IRA, and taxable accounts. This is so they can have enough money to travel, dine out, pay for costly long-term care expenses, and cover potentially reduced social security benefits.

No, the Rule of 55 isn’t the same as Rule 72(t). While both rules pertain to early withdrawals from retirement accounts, they are distinct provisions governed by different tax code sections.

The key differences include:
Type of account: The Rule of 55 applies only to employer-sponsored retirement plans, while Rule 72(t) applies to a broader range of retirement accounts, including IRAs.
- Age requirement: The Rule of 55 allows penalty-free withdrawals for specific employment-related separations at age 55 or older. Rule 72(t) allows penalty-free withdrawals based on specified distribution methods and timing.
- Withdrawal method: The Rule of 55 allows a one-time withdrawal or series of withdrawals from an employer-sponsored plan. Rule 72(t) requires taking substantially equal periodic payments over a specified period.

Best Financial Planner Washington DC

Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.

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District Capital is an independent, fee-only financial planning firm. We help professionals and entrepreneurs in their 30s and 40s elevate their finances and maximize their money. We are based in Washington, D.C and we work with people virtually nationwide.

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