Using the Rule of 55 to Take Early 401(k) Withdrawals

Employer-sponsored, tax-deferred retirement plans like 401(k) and 403(b) plans have strict rules about when you can access your funds. Generally, if you withdraw funds before age 59 ½, you’ll trigger an IRS tax penalty of 10%. The good news is that there’s a way to take your distributions a few years early without incurring this penalty, called the rule of 55. If you’re contemplating an early retirement, it is worth knowing how the rule of 55 works and when you can withdraw from a 401(k) without penalty.

If you have retirement planning questions, consider talking to a financial advisor who can help you create and manage your long-term financial plan.

What Is the Rule of 55?

Under the rule of 55, you can withdraw funds from your current job’s 401(k) or 403(b) plan without incurring a 10% tax penalty if you leave that job in or after the year you turn 55. (Qualified public safety workers can start taking withdrawals even earlier, at age 50.) This rule applies whether you were laid off, fired or simply quit your job. It does not apply to traditional or Roth IRAs.

Note that distributions are not completely tax-free, though. Like all withdrawals from a traditional 401(k) or 403(b), you do have to pay income tax. Only the 10% tax penalty is bypassed in this scenario.

In addition, note that employers are not obliged to allow early withdrawals. If they do allow them, they may require that you take out the entire amount in one lump-sum withdrawal. This could expose you to a higher income tax rate.

Additionally, the rule of 55 only applies to current—not former—401(k) or 403(b) plans. The government does not permit penalty-free withdrawals before 59 ½ from plans you had with a previous employer.

How to Use Rule of 55 to Fund an Early Retirement

If you’re thinking about early retirement, chances are you’ll need to take early withdrawals from your retirement account. Retiring early means you won’t have access to Social Security benefits, which means you’ll need to not only have to pay for your living expenses but also added expenses like health insurance. Using the rule of 55 to take early withdrawals can help cover those costs.

To start making withdrawals, you’ll have to prove to the plan administrator that you qualify. There are a few rules you’ll need to comply with to do so:

Age of retirement: You must leave your job during the calendar year you turn 55 or after to qualify for the rule of 55. This age requirement is lowered to 50 if you’re a public service employee.
Work: You must leave your job to start taking withdrawals. However, you can return to work later.
Retirement account: You can only withdraw funds from your most recent 401(k) or 403(b) account under the rule of 55.

Beyond simply meeting the criteria, it’s also important that you effectively plan the timing of those withdrawals due to tax considerations.“ If you were employed for most of the year and had a relatively high income, then it makes sense to not withdraw money under the rule of 55 in that calendar year, since it will add to your total income for the year and possibly result in you moving to a higher marginal tax bracket,” says Dave Lowell, CFP® and founder of Up Your Money Game.

In this particular scenario, it may make more sense to use other savings or take withdrawals from after-tax investments until the next calendar.This can help lower your taxable income, and thus the amount you pay in taxes.

Examples of Rule of 55 Cases

Here’s a look at how the rule of 55 may work in practice.

Let’s say you resign or are laid off from your job at 57. In this case, you may begin withdrawing from the 401(k) that you were contributing to when you left your company without penalty under the rule of 55. But then, say, at 57, you take a part-time job. The good news is that you can continue taking penalty-free distributions from that 401(k) plan, provided it was the plan you were contributing to when you resigned from your job. The one caveat is that you may only continue to take penalty-free withdrawals if you have not rolled your401(k) into another plan or an IRA.

Tax Considerations and Withholding on Rule of 55 Withdrawals

A couple discussing the 401(k) 55 rule with their advisor.

While the rule of 55 allows penalty-free access to 401(k) and 403(b) funds, regular income taxes still apply to all distributions. This means that each withdrawal will increase your taxable income for the year and could potentially push you into a higher tax bracket—especially if you take large lump-sum amounts or combine withdrawals with other income sources.

Plan administrators are generally required to withhold 20% of each withdrawal for federal income tax, unless you request otherwise or take substantially equal periodic payments. However, you may end up owing more or less tax than that depending on your total income and deductions for the year. If too little tax is withheld, you may owe money or face penalties when you file your return.

State income tax may also apply to your retirement account withdrawals, depending on where you live and your state’s treatment of retirement income. Some states fully tax 401(k) withdrawals, while others offer partial exemptions or don’t tax retirement income at all.

To manage the tax impact, some retirees coordinate their rule of 55 withdrawals with other tax planning strategies. This might include spreading distributions over multiple tax years, using Roth conversions for part of their balance or pairing withdrawals with deductions, such as large medical expenses.

Working with a tax professional or financial advisor can help you forecast the total tax liability tied to your early withdrawals and structure a withdrawal plan that minimizes unexpected tax bills. Being proactive about tax implications helps preserve more of your retirement savings and supports a more predictable income stream in early retirement.

Alternatives to Rule of 55 Withdrawals

The rule of 55 isn’t the only way to get money from your retirement plan early. For example, you won’t have to take penalty-free early withdrawals from a 401(k) for these reasons:

You become totally and permanently disabled.
You pass away and your beneficiary or estate is withdrawing money from the plan.
You’re taking distributions to pay deductible medical expenses that exceed 7.5% of your adjusted gross income.
Your distributions are the result of an IRS levy.
You’re receiving qualified reservist distributions.

You can also avoid the 10% early withdrawal penalty if early distributions are made as part of a series of substantially equal periodic payments, known as a SEPP plan. You must be separated from service to qualify for this exception if you’re taking money from an employer’s plan, but you’re not subject to the 55 or older requirement. The payout amounts are based on your life expectancy.

Bottom Line

Part of planning for retirement can be using the 401(k) 55 rule.

The rule of 55 allows you to take money from your employer’s retirement plan without a tax penalty before age 59.5. But that doesn’t necessarily mean you should. Whether an early retirement is right for you depends largely on your goals and overall financial situation.

“Retiring earlier than 62 means no Social Security income,” Lowell says. “The person needs to make sure they know where their income is coming from.”

For example, will you have a pension that pays out regular annuity payments to rely on? Or will you be able to draw from taxable investment accounts, savings accounts, CDs or other assets to cover your expenses in early retirement?

If you plan to retire early but you don’t think you’ll need to tap into your 401(k) just yet, consider what else you could do with it. Leaving it with your employer to continue growing is one option; rolling it over to an IRA is another. The more thought you give to how and when you’ll need to use those assets beforehand, the better you can position yourself for a financially sound early retirement.

Tips for Retirement Planning

Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If using a 401(k), don’t forget to take advantage of any employer match!