Imagine a couple who has done an exceptional job saving for retirement over their careers. They’ve consistently maxed out their retirement plans and have plenty of money to retire today if they want. There’s just one catch – they’re not 59-1/2 yet. How can they access their retirement funds without paying a penalty? That’s where the Rule of 55 comes into play.
What Is the Rule of 55?
The Rule of 55 isn’t really a rule at all. It’s simply an exception to the 10% penalty on withdrawals from retirement accounts made before age 59-1/2. If you retire between age 55 and 59-1/2, you can still access your current 401(k) or 403(b) without paying the 10% penalty. The rule applies regardless of the terms of your separation. So, whether you quit, get fired, or get laid off, you can still access your retirement funds.
Of course, as with all tax rules, there are caveats and exceptions. The Rule of 55 only applies if you retire during the year of your 55th birthday or later. That’s right – you don’t even have to be 55 yet, so long as you turn 55 during the year you retire. In fact, if you’re a police officer, firefighter, or EMT, you may be able to access these funds as early as age 50.
The Rule of 55 only applies to your current employer retirement plans. If you have older retirement plans from prior employers, you are not allowed to access them via the Rule of 55. However, there’s nothing stopping you from rolling these older plans into your current 401(k) or 403(b) before stepping away from work. Once rolled over, you could then have access to these funds at retirement.
It’s important to note that the rule does not apply to IRAs. It only applies to 401(k) plans, 403(b) plans, and any other qualified retirement plans covered under section 401(a).
When to Use the Rule of 55
If, like the couple in our example, you’ve done a great job of saving and can retire early without stress, the Rule of 55 gives you the flexibility to use retirement funds early. This can be advantageous for many reasons, including strategic Roth IRA conversions and reducing Required Minimum Distributions (RMDs) later in life.
The Rule of 55 could also come in handy for someone who’s been let go from work after they’re 55 and hasn’t found work yet. In this case, it’s not ideal, but it’s certainly better than paying the 10% penalty on withdrawals. Even if you eventually go back to work, you can still use the Rule of 55 to access your funds, so long as you’re withdrawing from the same account.
No matter what your situation, always consult with your CPA to determine the right amount to withdraw during a given year. While the Rule of 55 may allow you to avoid the 10% penalty on early withdrawals, you will still need to pay income taxes on whatever you take out.
When it comes to pre-age 59-1/2 withdrawals, the Rule of 55 isn’t the only game in town. Rule 72(t) allows withdrawals, but only in the form of “Substantially Equal Periodic Payments” that must run for at least 5 years. In comparison, the Rule of 55 is much simpler and more flexible.
If you need help with your early retirement withdrawal strategy, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.
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