How to Use the Rule of 55 to Take Early 401(k) Withdrawals
- November 11, 2022
Early retirement. It sounds amazing, doesn’t it? The idea that anyone could choose to walk away from their job to pursue their dreams is something most of us would love to be able to do. And the plot of nearly every pilot episode of a sitcom since the start of TV (I am old). You dream about what you’ll be able to do with all that extra free time, how you’re going to spend your days, and then reality sets in, and you remember all those things The Office has conditioned you to, like being behind a computer desk at 8:00 AM every day, meetings, and an office routine.
But what if I told you that you could retire early and get access to your retirement funds without any penalties? Often, there are penalties connected with taking early withdrawals from retirement accounts; however, there are also some exceptions. For example, one exception to the 401(k) early withdrawal penalty is known as the “rule of 55.” This allows you to take distributions from your 401(k) or 403(b) without paying the penalty when you are 55 or older.
What is the Rule of 55?
The Rule of 55 is a rule that allows you to take distributions from your 401(k) or 403(b) without penalty if you are at least 55 years old. The rule was created by the Internal Revenue Service (IRS) to help people save more money for retirement, as well as encourage employers to offer 401(k) plans.
The primary benefit of using the rule of 55 is that it allows you to access money from your retirement plan without paying a 10% penalty on top of income taxes on the distribution amount. If you’re looking to get access to extra cash quickly but don’t want to pay any penalties associated with early withdrawals, this could be an ideal solution for you.
How to Use the Rule of 55 to Fund an Early Retirement?
In order to use the Rule of 55, you must first check with your company to see if they offer retirement plans that allow employees to take advantage of the rule of 55. While many companies allow you to take this advantage, few don’t.
Here are the conditions that you must meet before taking a rule of 55 withdrawal.
Age of Retirement: If you want to take advantage of the rule of 55, you have to follow a few specific guidelines. You must quit your job after turning 55, or the calendar year of. This reduces to the age of 50 if you are a public service employee. You can’t retire earlier and then take withdrawals, or the rule of 55 doesn’t work.
Work: It’s important to leave your job when you start taking withdrawals under this rule. However, once you stop withdrawing funds, you can return back to your work. This means that you aren’t tied to retiring forever.
Retirement Account: You can only withdraw funds from your most recent 401(k) or 403(b) account for the rule of 55 to work.
Should You Use the Rule of 55?
The rule of 55 dictates that if you retire early, you can access your retirement funds without penalty. However, you’ll want to make sure that withdrawing early won’t put you in a difficult financial situation. To do this, you’ll need to understand your plan’s rules, and how you’ll manage those funds in the upcoming years. Once you have this information, you’ll be able to determine whether or not taking an early withdrawal is the right decision for you.
To make the decision-making process easier for you, below are some situations where using the Rule of 55 might not be the best choice.
- If using the Rule of 55 pushes you to a higher tax bracket, then it’s better to avoid it since you don’t want to pay your retirement money in taxes.
- If your plan requires a lump-sum withdrawal, then avoid using this rule because it may subject you to the usual income tax liability.
- Lastly, if you are younger than 55, then using this rule won’t be a suitable option for you since it’s not allowed, and doing that results in penalties.
If you use the rule of 55 to take early 401(k) withdrawals, you must assess your financial situation and determine whether it’s the right decision for you. We hope this blog post has provided you with some helpful information about the rule of 55, early 401(k) withdrawals, and retirement life.