The Rule of 55

The intricacies of retirement planning and wealth management often introduce several provisions and rules that many may find complex. One such provision is the ‘Rule of 55,’ a rule that pertains to early withdrawals from one’s 401(k) account. This guide aims to provide a comprehensive understanding of this rule in a structured and formal manner.

An Introduction to the Rule of 55

Under normal circumstances, withdrawing from a 401(k) prior to reaching the age of 59½ incurs a penalty, typically amounting to 10% of the withdrawal. The Rule of 55 serves as an exception to this stipulation. Specifically, if an individual departs from their job during or after the calendar year in which they turn 55, they are permitted to make withdrawals from their 401(k) without incurring the early withdrawal penalty. However, it’s imperative to note that standard taxes will still apply to these distributions.

Additionally, this rule is not exclusive to 401(k) plans; it is also applicable to 403(a) and 403(b) plans. Eligibility can be confirmed through the Summary Plan Description associated with one’s workplace retirement plan.

Key Considerations

1. If an individual left their employment before the calendar year they turned 55, they would not qualify for penalty-free withdrawals under this rule upon reaching 55. However, if they depart from employment after turning 55, they are eligible.
2. It is crucial to understand that the Rule of 55 is not applicable to Individual Retirement Accounts (IRAs). For those wishing to leverage the Rule of 55, funds must remain within the employer’s 401(k) plan. Transferring these funds to an IRA would render the Rule of 55 inapplicable.
3. The Rule of 55 strictly pertains to the 401(k) associated with the employer from whom one departs at or after the age of 55. If one has multiple retirement accounts, early withdrawal without penalty from other accounts would only be permissible after reaching the age of 59½.
4. If an individual secures new employment after initiating withdrawals under the Rule of 55, they can continue to make withdrawals from the 401(k) of their previous employer, provided that this was the account they contributed to upon their departure at or after 55.
5. The IRS requires pro-rata withdrawals of pre-tax and post-tax contributions from a 401k. This means you cannot only withdrawal your pre-tax contributions from your 401k in hopes of reducing your taxable income.
6. If you have made Roth contributions to your 401(k), those withdrawals typically remain tax-free. A careful evaluation of whether to withdraw from the Roth or the traditional account is advisable.
7. The IRS requires a minimum 20% tax withholding on withdrawals from 401k accounts. If you are in a lower tax bracket you are still required to follow the 20% minimum withholding rule.

For more information on the Rule of 55 please reference the IRS guide at https://www.irs.gov/publications/p575 or you may schedule an introductory call with one of Almega Wealth Management’s financial advisors.