Retiring Early? 5 Key Points about the Rule of 55 (2024)

If you've ever invested in a 401(k), 403(b), or similar tax-deferred plan, you likely know you're generally expected to keep the money in the account until you're at least 59 1/2—if you don't want to be stuck with a penalty. However, there is a way around the penalty if you want access to your money a little earlier.

With the rule of 55, you have the potential to begin taking distributions from your 401(k) before you normally could. Here's what you need to know about using the 401(k) rule of 55 to your advantage.

The IRS rule of 55 recognizes you might leave or lose your job before you reach age 59½. If that happens, you might need to begin taking distributions from your 401(k). Unfortunately, there's usually a 10% penalty—on top of the taxes you owe—when you withdraw money early.

This is where the rule of 55 comes in. If you turn 55 during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty. However, you must still pay taxes on your withdrawals.

Not only does the rule of 55 work with a 401(k), but it also applies to 403(a) and 403(b) plans. If you have a qualified plan, you might be able to take advantage of this rule. You can verify the status of your plan by checking with the Summary Plan Description you received (or can access electronically) for your workplace retirement plan.

Police officers, firefighters, EMTs, and air traffic controllers are considered public safety employees, and they get a little extra time to access their qualified retirement plans. For them, the rule applies in the calendar year in which they turn 50.

Double-check to ensure your plan meets the requirements and consider consulting a professional before withdrawing money.

Before you start taking distributions from multiple retirement plans, it's important to note the 401(k) withdrawal rules for those 55 and older apply only to your employer at the time you leave your job.

In other words, you can only take those penalty-free early 401(k) withdrawals from the plan you were contributing to at the time you left (or were fired from) your job. The money in other retirement plans must remain in place until you reach age 59 1/2 if you want to avoid the penalty.

Even if you're eligible to withdraw money penalty-free from your 401(k) or other qualified retirement plan early, consider it carefully. Just because you can doesn't mean you should. Remember, if you're taking money from your retirement account, it can no longer benefit from (potential) compounding returns. If you retire early, or if you were laid off and you need the distributions to cover living expenses, it could make sense. But if you get another job and cover your costs that way, it might not make sense to begin drawing down your 401(k).

Also, be aware your employer might automatically roll over your 401(k) account to an IRA once your 401(k) balance drops to $5,000 or below. You won't lose this money, but it may end up in an IRA that you did not choose.

Finally, if you made Roth contributions to your 401(k), these withdrawals are usually tax-free, so determine if taking withdrawals from your Roth account in the 401(k) plan makes sense or if you should withdraw from the taxable account.

Review your choices carefully and consider consulting with a retirement specialist to determine what might work for your situation.