What Is the Rule of 55? What You Need To Know

The Internal Revenue Service (IRS) has a rule called "the rule of 55," which says that workers who are 55 or older can take money out of their employer-sponsored retirement accounts without having to pay the penalty if they leave their jobs. With this rule, older workers who leave their jobs early don't have to pay a 10% penalty for taking money out of their retirement savings early. Only plans at work, like 401(k) and 403(b) plans, follow the rule of 55. Individual retirement accounts (IRAs) are not covered, and the rule of 55 only applies to workplace plans. Also, plans don't have to have this provision. Even if you use the "rule of 55" to get money out of your retirement plan, you would still have to pay regular income tax on it. Here's how the rule of 55 works and when it might be helpful.

Learning The Rule Of 55

Plans for retirement at work are meant to help people save money for their old age. Most of the time, you have to pay a 10% penalty if you take money out of these plans before you're 59 and 12 months old. The rule of 55 is one of the things that doesn't follow this rule. When both of the following are true, employees can take money out of their 401(k) or 403(b) plan early without paying the penalty:

• Withdrawals are made when the worker is 55 or older.
• When you quit your job, you have withdrawals.

For example, let's say your company will lay you off right after you turn 55 because they need to save money. With the rule of 55, you could take money out of your 401(k) or 403(b) without paying the 10% early withdrawal penalty. But you don't have to be fired or put in a lower position to use the rule of 55. You could also use it to quit your job early or retire early.

401(k) Loans vs. the Rule of 55

The rule of 55 only applies when you leave your job. If you still work for the same company that holds your 401(k), you can't use it. But if your plan lets you, you could take out a loan from your 401(k).

Workers can borrow up to 50% of their vested account balance or $50,000, whichever is less, from the IRS. Most of the time, this money is paid back through salary deferrals over five years at a low-interest rate. During this time, you may or may not be able to keep adding to your 401(k), depending on the plan.

Things To Think About Before Taking A 55?

Before taking a rule of 55 withdrawals, here are some things to consider and the conditions that must be met.

• Having a retirement plan gives them: You can take money out of a 401(k), 403(a), or 403(b) in your company's plan when you turn 55. Some plans don't let you take money out until you are 59, 12, or even 62.
• Age 55 or older: You quit a job in or after the year you turned 55, either on your own or because you were fired.
• The plan must include money. You know that your money must stay in the employer's plan for a certain amount of time before you can take it out and that you can only take money out of the company where you currently work. Rule 55 says that if you move them to an IRA, you lose the tax protection.
• Possible lost gains: You know that if you take money out of your investments too soon, you will lose any improvements you may have made.
• Assume you wait until the beginning of the following calendar year to start the Rule of 55 payments. Because you will not be working, your tax liability must be reduced.
• Suppose you are a skilled police officer, firefighter, EMT, corrections officer, or an ATC (air traffic controller). In that case, you might be able to start your job five years earlier. Make sure you have a qualified plan to take money out before or after you turn 50.

But, as with any financial decision, you should talk to a trusted advisor or tax expert first to ensure no surprises.

Bottom Line

You usually don't have to pay the 10% IRS tax penalty on withdrawals made beyond 59 and a half if you can wait until that age. However, suppose you have enough money to retire early and are not concerned about it. In that case, the rule of 55 may be an excellent idea. However, suppose you are forced to withdraw funds from your retirement account at 55 until you can find a new career, start a company, or produce money in another manner. In that case, the rule of 55 may be precisely what you need in the short term.