The Rule of 55 lets you tap your 401(k) penalty-free before 59½ — but less than a third of eligible workers use it

Most Americans cognize they can't commencement withdrawing from their workplace 401(k) oregon 403(b) until property 59½ — astatine slightest not without triggering a 10% aboriginal withdrawal penalty.

But galore don't cognize of an objection to that regularisation that allows you to retreat arsenic aboriginal arsenic property 55 without triggering a punishment (1).

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If you permission your occupation successful the calendar twelvemonth that you crook 55 — voluntarily oregon not — this taxation interruption could assistance to money an aboriginal retirement.

"Knowing I could entree that wealth penalty-free has made a immense difference," Jon Barker, a retired teacher successful Seattle, told The Wall Street Journal. Without it, helium says helium wouldn't person been capable to instrumentality aboriginal retirement. And though helium inactive had to wage taxes connected his 403(b) withdrawals, helium avoided the aboriginal withdrawal punishment (2).

It's called the Rule of 55 — and you could beryllium missing retired if you don't cognize astir it. So, for example, if you permission your occupation and rotation implicit your 401(k) into an idiosyncratic status relationship (IRA), it would beryllium excessively precocious to instrumentality vantage of this taxation break.

But the Rule of 55 isn't the close determination for everyone. Nor is it a'magic aboriginal status tool. Here's what you request to know.

How the Rule of 55 works

The Rule of 55 allows you to marque penalty-free withdrawals from your astir caller employer's 401(k) oregon 403(b) erstwhile you permission that occupation — whether you take to permission oregon you're laid disconnected — successful the twelvemonth you crook 55 oregon later. This lone applies to your existent job, not workplace status plans from erstwhile employers.

While you debar the aboriginal withdrawal penalty, you inactive person to wage income taxation connected immoderate funds withdrawn from the account. The Rule of 55 besides applies to Roth 401(k)s, but the five-year regularisation for qualified withdrawals is inactive successful play. That means you indispensable person held your relationship for astatine slightest 5 years earlier you tin instrumentality tax-free withdrawals.

However, the Rule of 55 doesn't use to IRAs oregon rollovers. "Rollover IRAs from 401(k)s are not included successful this regularisation and withdrawals could incur a penalty," Michael Rusinak, vice president of Fidelity Financial Solutions, writes successful a Fidelity blog (3).

Still, considering that immoderate Americans discontinue earlier than expected, it's utile to cognize astir this rule.