When Can You Withdraw? 401(k)s and the Rule of 55

The IRS rule of 55 recognizes you might leave or lose your job before you reach age 59½. If that happens, you might need to begin taking distributions from your 401(k). Unfortunately, there's usually a 10% penalty—on top of the taxes you owe—when you withdraw money early. 

This is where the rule of 55 comes in. If you turn 55 (or older) during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty. However, you must still pay taxes on your withdrawals.

Not only does the rule of 55 work with a 401(k), but it can also apply to other qualified retirement plans, such as a 403(b) plan. If you have a retirement plan from your employer, you might be able to take advantage of this rule. You can verify whether or not you can use this exception by checking with the Summary Plan Description you received (or can access electronically) for your workplace retirement plan.

Before you start withdrawing money from your 401(k), it's important to understand five things about the rule of 55. 

Public safety employees, such as police officers, firefighters, EMTs, and air traffic controllers, get a little extra time to access their qualified retirement plans. For them, the rule applies in the calendar year in which they turn 50.

Double-check to ensure your plan meets the requirements and consider consulting a professional before withdrawing money.

Before you start taking distributions from multiple retirement plans, it's important to note the 401(k) withdrawal rules for those 55 and older apply only to the plan with your employer at the time you leave your job.

In other words, you can only take those penalty-free early 401(k) withdrawals from the plan you were contributing to at the time you left or were let go. The money in other retirement plans must remain in place until you reach age 59½ if you want to avoid the penalty and potential additional tax liabilities.

The rule of 55 doesn't apply if you left your job at, say, age 53. You can't start taking distributions from your 401(k) and avoid the early withdrawal penalty once you reach 55. However, you can apply the IRS rule of 55 if you're older and leave your job. If you get laid off or quit your job at age 57, for example, you can start taking withdrawals from the 401(k) you were contributing to at the time you left employment.

The rule of 55 specifies when you can withdraw from 401(k) accounts. It doesn't apply to individual retirement accounts (IRAs). If you leave your job for any reason and you want access to the 401(k) withdrawal rules for age 55, you need to leave your money in the employer's plan—at least until you turn 59½. Once you roll that money into an IRA, you can no longer avoid the penalty. And if you've been contributing to an IRA as well as your 401(k), you can't take penalty-free distributions from your IRA without meeting certain requirements.

Finally, you can keep withdrawing from your 401(k), even if you get another job later. Let's say you turn 55 and retire from work. You decide you need to take penalty-free withdrawals under the rule of 55 and begin to take distributions from that employer's plan. Later, at age 57, you decide you want to get a part-time job. You can still keep taking distributions from your old plan as long as it was the 401(k) you were contributing to when you quit at age 55—and you haven't rolled it over into another plan or IRA.

Even if you're eligible to withdraw money penalty-free from your 401(k) or other qualified retirement plan early, consider taking early distributions carefully. Just because you can take withdrawals, doesn't mean you should. Remember, if you're withdrawing money from your retirement savings, they can no longer benefit from potential compounding returns.

If you retire early, or if you were laid off and need the distributions to cover living expenses or medical expenses, it could make sense. But if you get another job and cover your costs that way, it might not make sense to begin drawing down your 401(k).

Also, be aware your employer might automatically roll over your 401(k) to an IRA once your 401(k) balance drops below a certain level. You won't lose this money, but it may end up in an IRA, which does not allow penalty-free early withdrawals.

Finally, if you made Roth contributions to your 401(k), these withdrawals are usually tax-free, so determine if taking withdrawals from your Roth account in the 401(k) plan makes sense or if using money saved in a taxable brokerage account is a better option.

We recommend reviewing your choices carefully and consider working with a tax or financial planning professional to determine which options work for your situation.