If you’ve been dutifully contributing to your 401(k) for years, you may be wondering when you can access the funds. Well, technically you could withdraw from it any time you want, but if you’re younger than 59 1/2 years old, you’ll be penalized for doing so.

That can be disappointing to hear, especially if you want to retire before you reach the age of 59 1/2. If you can hold out until you turn 55 years old, however, there’s an exception you could possibly leverage—the Rule of 55. This provision allows you to access your 401(k) or 403(b) before you hit 59 1/2 without incurring an early withdrawal penalty.

Ready to pull funds from your 401(k) or 403(b), but don’t want to wait until you’re 59 1/2? Keep reading to learn more about the Rule of 55, how it works, the pros and cons of enacting it, and more.

What Is the Rule of 55?

The Rule of 55 is an IRS rule that lets people make penalty-free withdrawals from their employer’s retirement plan, such as a 401(k) or 403(b), if:

  • They leave that employer
  • They turned 55 (or older) the year that they left their company

In other words, the Rule of 55 only applies to former employer-sponsored retirement plans. If you’re 55, you can’t suddenly start taking withdrawals from your current employer’s 401(k) plan while you’re still working for them without incurring a 10% early withdrawal penalty.

More information here:

How Does the Rule of 55 Work?

There are no guarantees that you’re going to remain with your employer until you turn 59 1/2. You could resign before then, decide that you want to retire early, or get laid off. These circumstances are part of the reason why the Rule of 55 exists.

While this IRS provision can be beneficial, there are rules to keep in mind to ensure you’re not subjecting yourself to that 10% early withdrawal penalty:

  • The Rule of 55 only applies to 401(k) and 403(b) plans—not IRAs.
  • The rule also only applies to the retirement plan of the employer you just left.
  • You have to leave your company during or after the year that you turn 55 years old.
  • You must keep the money in your employer’s plan before withdrawing it.
  • Withdrawals have to be made from your current employer’s plan; rolling funds into an IRA could forfeit your Rule of 55 tax protection.

Pros and Cons of the Rule of 55

If you want to retire in your mid-50s, get laid off before you turn 59 1/2, or suffer health issues that prevent you from working into your 60s, the Rule of 55 can be beneficial. Like with most major financial decisions, you should consider the advantages and disadvantages before making the move. Using the Rule of 55 is no exception.

Here are the pros and cons to think about before you consider withdrawing from your eligible retirement plan using the Rule of 55:

Pros

  • Early withdrawal penalty avoidance: This is the key reason for using this rule. You can access your retirement savings before you turn 59 1/2 without getting hit with that 10% penalty.
  • More funds for your early retirement: If you retire at 55, Social Security is still at least seven years away. The money you pull from your 401(k) or 403(b) can help you cover expenses until you can start collecting Social Security (or other retirement income).
  • Income if you lose your job: In the event your unemployment wasn’t your choice but you’re not interested in finding another job in your mid to late 50s, your retirement funds can give you some financial cushion without having to deal with penalties.

Cons

  • Depleted retirement funds: If you start withdrawing from your 401(k) or 403(b) at 55, that’s less time for your money to grow. You also run the risk of running out of money later in your retirement.
  • Bigger tax bill: Withdrawing retirement funds before turning 59 1/2 is costly because you’re typically charged the 10% early withdrawal fee and a 20% income tax. The Rule of 55 shields you from the former, but the tax remains. If you make large withdrawals from your retirement, you could increase your taxable income and potentially move yourself into a higher tax bracket.
  • Only one retirement fund is eligible: You can’t withdraw from a 401(k) from an old employer using the Rule of 55, only the company you just left. The rule also doesn’t apply to IRAs—you could lose the rule’s protections if you move your funds to an IRA.
More information here:

Rule 72(t) — A Rule of 55 Alternative

If the cons above gave you pause about enacting the Rule of 55, other options are at your disposal, such as Rule 72(t). This IRS exception also lets you access your retirement funds before you reach 59 1/2 years old without incurring the 10% early withdrawal penalty. The key difference from the Rule of 55 is that you can use Rule 72(t) with IRAs and other retirement accounts.

Rule 72(t) may be more flexible than the Rule of 55 when it comes to the types of accounts you can use, but it’s not without rigidity. With Rule 72(t), you have to take a series of Substantially Equal Periodic Payments (SEPP) from your retirement account. The amount of the withdrawals is calculated with IRS-approved methods, and you have to keep taking these payments for five years minimum, or until you turn 59 1/2—whichever comes first.

If you opt for Rule 72(t), you must remain on the established withdrawal schedule, or you could be subject to penalties on your past transactions and interest.

The Bottom Line

Whether you should take advantage of the Rule of 55 (or an alternative) comes down to your individual situation. If you desperately want to get away from the daily grind and get on with your retirement, using this rule can be a great way to do so without incurring early withdrawal penalties. It’s also a nice financial backstop if you’re unable to work full-time anymore or are let go before you turn 59 1/2.

On the other hand, if you’re in a position to hang in there until 59 1/2, you won’t have to worry about early withdrawal penalties, SEPP, or anything else. You can make withdrawals as you see fit.

So, if you’re approaching 55 and retirement is on your mind, know that there’s a penalty-free way to access your 401(k) or 403(b) before turning 59 1/2, but it doesn’t come without a few disadvantages.

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