Planning to retire between ages 55 and 59.5?
When planning for early retirement, it is important to consider taxes and penalties when designing a withdrawal strategy which includes tax-advantaged retirement accounts like 401(k)s and 403(b)s. Typically, withdrawals from 401(k) or 403(b) accounts prior to age 59.5 will result in a 10% penalty on top of ordinary income taxes. However, if you separate from your employer in the calendar year in which you turn 55* or later, your withdrawals from your recent employer's retirement plan prior to age 59.5 will be penalty-free in accordance with the IRS Rule of 55. Your method of separation doesn’t matter whether you were laid off, fired, or quit. It’s the timing that matters.
Early Retirement Planning Strategies Surrounding the Rule of 55
If you are planning to retire between the ages of 55 and 59.5 and want to withdraw money from your 401(k) or 403(b) plans penalty-free during early retirement (congrats!) by utilizing the IRS Rule of 55, here are steps to consider:
- Confirm that your employer’s plan permits early withdrawals.
- If you are close to age 55, do not quit until January 1st of the calendar year in which you turn 55 years old. For example, if you turn 55 in 2022, do not quit before December 31, 2021.
- Roll over retirement accounts from previous employers into your current 401(k) or 403(b). Many retirement plans will allow you to roll over retirement account balances from former employers. The Rule of 55 will only allow penalty-free withdrawals from your retirement account at the employer from which you separated.
- Many employers will let you roll funds from an IRA into your 401(k)/403(b) if the funds originally came from a former employer’s retirement plan. Similar to the step mentioned above, rolling over your IRA into your current 401(k)/403(b) will help you maximize the amount you can withdraw penalty-free using the Rule of 55.
- Do not roll your 401(k) or 403(b) account into an IRA after you leave your employer between the ages of 55 and 59.5. The Rule of 55 does not apply to IRA accounts. It’s better to keep your retirement accounts at your recent employer to maintain the ability to make penalty-free withdrawals.
As always, it’s best to consult your trusted financial professional to determine your best course of action regarding the Rule of 55 and early retirement. Do not allow your advisor to roll your retirement account out of your employer’s plan until you’re confident that you will not utilize the Rule of 55 for early withdrawals between the ages of 55 and 59.5.
*For qualified public safety employees such as firefighters, police officers and air traffic controllers, the Rule of 55 applies in the calendar year you turn 50 years old.