What Is the Rule of 55?

The Rule of 55 Explained

By

Melissa Phipps

Updated on December 1, 2022

Reviewed by

Michael J Boyle

Fact checked by Hilarey Gould

A piggy bank cracked open exposing money inside with a hammer and coins next to it on a desk. Text reads: What Is the IRS Rule of 55? Allows an employee who is laid off, fired, or who quits a job between the ages of 55 and 55 Â½ to pull money out of a 401K or 403b plan without penalty. Applies to workers who leave their jobs anytime during or after the year of 55th birthdays. — Photo:
The Balance / Emilie Dunphy

Definition

The rule of 55 is an IRS provision that allows workers age 55 and older who leave their job to withdraw funds from their employer-sponsored 401(k) or 403(b) without paying a tax penalty.

Key Takeaways

If you are 55 or older and lose your job or quit, you can withdraw money from your 401(k) or 403(b) without paying a tax penalty.
If you retire before age 59 1/2, you have another option known as the Substantially Equal Periodic Payment (SEPP) exemption (IRS Section 72(t) distribution).
If you can wait to take retirement account distributions until at least age 59 1/2, your best bet is to keep working and contributing to your retirement account to minimize taxes and maximize returns.

How Does the Rule of 55 Work?

If you have a 401(k) or 403(b) plan through work, you may know there is usually a 10% penalty for withdrawing any of the funds before you reach age 59 1/2. One exception to this rule affects people not yet retired—those between ages 55 and 59 1/2.

The rule of 55 affects how and when you can access your retirement savings. If you are between ages 55 and 59 1/2 and get laid off or fired, or you quit your job, the IRS rule of 55 lets you pull money out of your 401(k) or 403(b) plan without penalty. It applies to workers who leave their jobs anytime during or after the year of their 55th birthday.

Example of the Rule of 55

For example, suppose you're 57 years old and are laid off from your job. Now that you don't have income from work, you may need to dip into your 401(k) funds. If you were younger than 55, you would have to pay a 10% penalty in order to do that. However, per the Rule of 55, because distributions were made to you after you separated from service with your employer and after the year you reached age 55, you can take penalty-free distributions from your employer-sponsored retirement savings account.

Note

There is a slight catch. The rule of 55 only applies to assets in your current 401(k) or 403(b), meaning the one you invested in while you were at the job you most recently left at age 55 or older.

The rule does not apply to any retirement plans from previous employers, such as 401(k) or 403(b). You would have to wait until age 59 1/2 to begin withdrawing funds from those accounts without paying the 10% penalty.

There is a strategy to use if you know you will be leaving the job. You can get penalty-free access to plans from former employers if you roll them into your current 401(k) or 403(b). Once that is done, you can leave your current job before age 59 1/2 and withdraw the money using the rule of 55.

The rule of 55 also does not apply to individual retirement accounts (IRAs). If you leave a job and then roll over your 401(k) assets into an IRA, you can't take penalty-free distributions until you reach 59 1/2 (unless you withdraw funds because you're disabled, use the money for education expenses, use it to buy a home, or another qualified exception).

Alternatives to the Rule of 55

The rule of 55 is not the only way to take penalty-free distributions from a retirement plan. There's another way to take money out of 401(k), 403(b), and even IRA retirement accounts if you leave a job before the age of 59 1/2. It's known as the Substantially Equal Periodic Payment (SEPP) exemption, or an IRS Section 72(t) distribution.

A SEPP plan has a twist. You start by estimating your life expectancy. Then use that to calculate five similar size payments from a retirement plan for five years in a row before the age of 59 1/2. What's different is that these distributions can occur at any age—they're not bound by the same age threshold as the rule of 55.

Should You Take Advantage of the Rule of 55?

The ability to take money out early can be a great safety net if you must retire before age 59 1/2. If you can wait to find another job, a part-time job, or work as a consultant, it might make more sense to let the money continue to grow tax-deferred well into your 60s.

Taking retirement distributions early could decrease the long-term value of your portfolio, particularly if the market is not doing so well during your initial years of retirement.

Note

If you expect to live a long life, early distributions could put your future income at risk.

Make all portfolio timing choices with care. Taking taxable retirement plan distributions during a year when you owe less in taxes can be a smart way to reduce your total payment.

On the other hand, taking money out of your plan during a higher-income tax year could create needless tax headaches. Work with a tax advisor, a financial planner, or your retirement plan administrator to create a withdrawal strategy that will work for you over time.

Frequently Asked Questions (FAQs)

How much can I withdraw using the rule of 55?

Under the rule of 55, you can take penalty-free distributions from your most recent employer-sponsored 401(k) or 403(b) if you're age 55 or older and were laid off, fired, or quit your job. The amount you can withdraw will depend on the amount of money in your 401(k) or 403(b) account, and it is limited to your compensation multiplied by the number set for that tax year (it's adjusted for the cost of living when needed).

When did the rule of 55 start?

The rule of 55 was put in place in 1988 as a part of the Technical and Miscellaneous Revenue Act of 1988, which made amendments to the tax code of 1968.

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