Understanding the rule of 55: A comprehensive guide to early retirement

Tyler Anderson profile photo

Tyler Anderson, CFP®

Mint Hill Wealth Management
Office : 833-421-1140

Contributing to a 401(k) or 403(b) plan is easy enough. But getting your money back out is a different story. Pulling this money out of these workplace retirement accounts before you turn 59 ½ often results in a substantial penalty fee on top of income tax.

However, the IRS gives people who have reached age 55 an option to access their 401(k) penalty-free if they leave their jobs and want retirement fund access at 55. This "rule of 55" could save serious money if you want to retire early or need to make a one-time withdrawal from your plan to cover a major expense.


The rule of 55 can help middle-aged 401(k) account holders plan early retirement. vgajic/Getty Images

What is the rule of 55?

Rule of 55 basics: The rule of 55 allows you to access your 401(k) or 403(b) funds without the usual 10% early withdrawal penalty. If you part ways with your employer the year you turn 55 (or later), you're eligible for the rule of 55. This rule stands as an exception to the standard IRS regulations on premature distributions from employer-backed retirement accounts before reaching 59 1/2. 

To discourage people from prematurely using their retirement saving for non-retirement expenses, the IRS penalizes early withdrawals from a 401(k)  — "early" being defined as any age before 59 1/2. An early withdrawal automatically gets hit with a 10% penalty. 

But in certain circumstances, the IRS will make an exception and waive the penalty. The rule of 55 is one of those exceptions and financial strategies for early retirees. It's a critical strategy for folks considering early retirement as it helps bridge the gap between leaving the workforce and accessing retirement funds.

Understanding the rule's complexities is the first step in avoiding pitfalls and maximizing benefits. You must meet certain criteria to qualify for the rule of 55, such as: 

  • Age requirement: Under the rule of 55, you're eligible to make an early withdrawal from your retirement account if you leave your job between the ages of 55 and 59 1/2. Government public safety workers (law enforcement, firefighters, EMS responders, etc.) are eligible for early withdrawal at age 50. 
  • Employment termination: The age 55 retirement rule only applies when you quit your job voluntarily or are fired. The year you leave your job must also be the same calendar year that you turn 55 or older, as you cannot age into the rule of 55. So, if you decide to retire at age 54, you wouldn't be eligible for the rule of 55, even after your 55th birthday.
  • Plan specificity: The rule only applies to your most recent employer's 401(k) or 403(b). Funds in an IRA or an older 401(k) plan from a previous employer are not applicable. That said, you may be able to make the money from older accounts qualify by rolling over old 401(k) funds into your current retirement plan.  
  • It may not apply to your 401(k). While employers can allow early distributions (IRS speak for withdrawals) to the departing 55-year-old employees, they are not obligated to do so. So, asking your company's 401(k) plan administrator is crucial if early withdrawals are allowed.

Bear in mind that regardless of the rule of 55, withdrawals are still subject to income tax. Your plan provider may also withhold 20% on taxable distributions.

How to take advantage of the rule of 55

While it's generally advised not to touch your retirement savings for as long as possible, there may be times when tapping into it makes financial sense.

For example, if you've lost your job at 55 and don't have adequate emergency funds, you'll need money to cover certain expenses like rent or mortgage payments. The rule of 55 may also be a deciding factor for those who are considering early retirement.

In any case, you should consider the timing of your withdrawal, both in the context of your age and the tax implications of early retirement. An early withdrawal in the year you retire will increase your taxable income. This might bump you into a higher tax bracket. So waiting to make your first withdrawal until at least the next January after your job exit could save you money on your tax bill.

Be wary of solely relying on 401(k) penalty-free withdrawals, as it may cause you to drain all your retirement savings too quickly. If applicable, you should consider other savings and income sources. 

Alternatives to the rule of 55 

If you don't meet the eligibility requirements for the rule of 55, here are other ways to avoid the 10% penalty. 

Take a SEPP

Also known as an IRS Section 72(t) distribution, a Substantially Equal Periodic Payment (SEPP) lets you take out money before you turn 59 ½ in equal annual distributions. You can establish one of these plans at any age, but you must agree to receive equal payments for at least five years or until age 59 ½ (whichever comes later). These withdrawals are exempt from the 10% penalty but still incur income tax.

Hardship distributions

The IRS also waives the 10% penalty if you need to withdraw from your 401(k) due to an "immediate and heavy financial need." These can include medical expenses, costs for purchasing a principal residence (excluding mortgage payments), and educational fees. 

401(k) loan:

You can take out a loan on your 401(k), a max of $50,000 or 50% of your vested balance (whichever is less). The interest you pay on these loans goes back to you, specifically into your 401(k).

Your options will vary based on your employer. Some might not allow you to take out a loan, for example. The disadvantages will also vary by employer. Some may not let you deposit into your 401(k) while you have an outstanding balance on your loan. 

Rule of 55 — Frequently asked questions (FAQs)

How does the rule of 55 work?

Can I use the rule of 55 if I get another job?

Can I withdraw from my 401(k) at 55 without penalty?

At what age can you withdraw from a 401(k) without paying taxes?

Is the rule of 55 worth it?

Just because the rule of 55 makes penalty-free withdrawals possible, it doesn't necessarily mean you should rush to tap your 401(k). The longer your money is invested, the more time you give compound interest to work its magic on your tax-deferred investments.

While rule 55 offers flexibility, a holistic approach to retirement planning (including tax considerations and income diversification) is crucial for long-term financial stability. Avoiding early retirement withdrawals is generally considered the better option. 

But you may ultimately decide that an early 401(k) withdrawal is right for your situation, especially if you're retiring early. And by taking advantage of the rule of 55, you can send more of those withdrawals to your own pocket and less to the IRS.

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Tyler Anderson profile photo

Tyler Anderson, CFP®

Mint Hill Wealth Management
Office : 833-421-1140