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MOST PEOPLE THINK their retirement accounts are completely locked until age 59½ due to the 10% early withdrawal penalty, but that’s not really true. There are many ways to access your money earlier without the penalty, and knowing them can give you flexibility. Of course, you shouldn’t be touching your retirement accounts unless you’re ready to retire.
Here are some distributions that are not subject to the 10% penalty, per the IRS list:
But what if you wanted to withdraw funds to pay for living expenses during early retirement?
This is where a Rule of 55 could come into play.
Rule of 55
You may be familiar with the series of substantially equal periodic payments (72t) exception that allows you to establish a withdrawal plan based on your life expectancy, interest rates, IRA/401k balance, and the method you choose to calculate.
The Rule of 55 is actually more flexible than a 72(t) plan and much simpler to execute.
Per the IRC, if the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit or defined contribution plan), the 10% penalty will not apply.
In simple terms, if you quit your job in the calendar year when you turn 55 or older, you can start withdrawing from your retirement plan. This exception only applies to qualified plans, like 401(k), 403(b) or 457(b). It does not apply to IRAs.
Here’s a quick planning opportunity if you may be using the Rule of 55:
Roll over all of your old 401(k), 403(b), or 457(b) plans into your current plan, because the rule only applies to your most recent qualified plan. Also, you could roll over your old IRAs into the current plan, but not every 401(k) plan accepts rollovers from IRAs, and processing can take time. You have to make sure the rollover is completed before you separate from your employer; otherwise, those funds won’t qualify for the Rule of 55 exception.
Note that as long as your separation from service (retirement, layoff, resignation, etc) happens in the same calendar year that you turn 55 (or later), the 10% early withdrawal penalty does not apply to withdrawals from that employer’s plan. For example, you could quit your job on 11/1/2025, turn 55 on 12/1/2025 and still withdraw money with the exceptions applied. The reason for separation does not matter.
However, if you quit your job at 52, you cannot start withdrawing at 55 without incurring the 10% penalty, since you separated from service before reaching age 55.
Qualified Public Safety Employees
If you are a qualified public safety employee, you can start withdrawing after the year in which you turn 50. The definition of qualified public safety employees includes:
Important note
While the Rule of 55 can be a powerful tool, your employer’s 401(k) plan must allow partial withdrawals for it to actually work as intended.
Some plans only permit a lump-sum distribution after separation from service. If that’s the case, you’d be forced to withdraw the entire balance at once, which could trigger a massive tax bill and ruin the strategy.
That’s why it’s important to check your plan’s withdrawal policy before you leave your job. Contact your HR department or plan administrator and ask whether partial, periodic withdrawals are allowed after separation.
If your plan doesn’t allow them, you may want to consider using a 72(t) plan strategy instead
.
Taxes
Keep in mind that these exceptions only waive the 10% early withdrawal penalty, not the income tax.
You’ll still owe ordinary income tax on any distribution from a pre-tax account, regardless if you use any of the exceptions. This is why it’s important to analyze whether a pre-tax or Roth account is best to contribute to during your working years, and to plan ahead.
If your plan does allow the partial withdrawals and you end up using this strategy, it could be a good way to lower your pre-tax balance to prevent future “tax hikes” due to RMDs, Social Security or pension.
In the end, it’s good to be aware of all your options so that you can plan ahead, minimize taxes and improve your liquidity options.
Bogdan Sheremeta is a licensed CPA based in Illinois with experience at Deloitte and a Fortune 200 multinational.
Please add that spouses who inherit IRAs from their spouse before RMD are required can take distributions before age 59 1/2 without penalty. You do still have to pay ordinary income taxes on any distributions.
Excellent timing for this article! I retired on my 55th birthday and am contemplating beginning to take some distributions from my retirement accounts (all held in a 403b plan with the employer I retired from) starting in January (when I will still be 58). Trying to figure out all the rules related to avoiding the early withdrawal penalty is complicated. Thanks for providing me with more useful information on the subject!
Thanks for your article and these ideas. It is really difficult to learn the WHOLE story. You have to be a CPA or attorney to fully understand so many possibilities. Just like Insurance, you really do not know all the in’s and out’s until you need to use it.
Thank you Bogdan. I find these columns about the nuances of finances and taxes most helpful.
Yes, I know someone who took advantage of this to retire early at age 56,
A new tax client came to my office. A widow, age 55. She had significant income from early distributions that incurred the 10% penalty. I examined her prior tax returns, finding the same situation in prior years. I left a message on her financial advisor’s voice mail. He returned my call in a panic, having missed the fact that the mutual fund company had assigned code 1, early distribution with no exceptions to her form 1099-R. He contacted the company and had the mistake corrected.
I amended her prior three tax returns, securing about $8,000 in refunds and interest. Her prior tax returns were prepared at a CPA’s office. A CPA should have caught the error, but I suspect that the tax return was actually prepared by admin staff or a seasonal worker. The CPA is supposed to review returns prepared by underlings, but in reality, most are too busy with more complex tax returns to bother.
Thanks Dan for pointing this out! It will force me to be more diligent on my own 1099s.
That’s why we all should educate ourselves on these important rules. At least we can mention to our CPAs, tax preparers.
Excellent article. One nit; I think governmental 457b plans don’t have the irs age requiremet/penalty after separation. I don’t know about non-governmental 457b plans.
I recall trying to explain some of this when managing retirement plans. These rules just reinforce the idea the whole system is too darn unnecessarily complicated.
What drives me crazy are the different rules and limits between 401k and IRAs and other similar plans like 403b. Why can’t there just be one set of rules for all retirement plans?
Agreed. If there is any logic in having different rules for IRAs and 401(k)s, it totally escapes me.