What Is the Rule of 55?

The Rule of 55 Explained

Definition

The Rule of 55 is an IRS regulation that allows those 55 and older to withdraw funds from their 401(k) or 403(b) without a tax penalty.

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 ½ 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.
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The Balance / Emilie Dunphy

Definition and Example of the Rule of 55

If you have a 401(k) plan, 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 those not yet retired—those between ages 55 and 59 1/2.

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 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 withdraw from your retirement savings penalty-free.

How the Rule of 55 Works

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 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.

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 leave 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 were to move assets into a rollover IRA upon leaving your job, you would not be eligible for early withdrawal with no penalty.

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 Either Distribution?

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 funds early could decrease the long-term value of your portfolio, particularly if your initial years of retirement are bad ones for the market.

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. 

Key Takeaways

  • If you are 55 or older, you may be able to withdraw funds from your 401(k) or 403(b) without a tax penalty.
  • Another option—if you retire before age 59 1/2—is the Substantially Equal Periodic Payment (SEPP) exemption, also known as an IRS Section 72(t) distribution.
  • If you can wait to retire until age 59 1/2, it could be best to keep working for a few more years so your money can keep growing.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." Accessed Feb. 16, 2022.

  2. Internal Revenue Service. "Topic No. 558 Additional Tax on Early Distributions from Retirement Plans Other than IRAs." Accessed Feb. 16, 2022.

  3. Internal Revenue Service. "Publication 575 (2020), Pension and Annuity Income." Accessed Feb. 16, 2022.

  4. Internal Revenue Service. "Retirement Plans FAQs Regarding Substantially Equal Periodic Payments." Accessed Feb. 16, 2022.

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