$Retirement Nerd

Rule of 55 – Accessing Tax-Sheltered Accounts to fund (an early) Retirement

Rule of 55 – Accessing Tax-Sheltered Accounts to fund (an early) Retirement

I can’t drive 55

SAMMY HAGAR

Driving 55 has nothing to do with retirement planning, but IRS Topic No. 558 (more commonly known as the “Rule of 55“) defines an allowance to withdraw funds before age 59 1/2 from a 401k or 403b plan without incurring the 10% penalty. Since 401k and 403b accounts are funded with “pre-tax” dollars, you will generally need to pay income tax on withdrawals. To discourage us from withdrawing funds too early, the IRS will levy a 10% penalty on top of the tax if you are not 59 1/2 years old or older.

In a previous article, we discussed building up our passive income in taxable accounts to fund our expenses when we stop working. We need to increase this taxable income to cover the timeframe until we can tap our social security and tax-sheltered retirement funds without the 10% penalty. We did not start focusing on taxable accounts until the last few years, so we need to consider options to access our tax-sheltered nest egg to generate sufficient income.

Per the Rule of 55, we can withdraw funds from our 401k or 403b starting in the calendar year that we turn age 55 or older, without the 10% penalty! Once we hit age 59 1/2, this is no longer relevant, but this sounds like a great option. If you are a “qualified public safety employee” (federal, state, or local), this rule actually may kick in for the calendar year that you turn 50 years old. The rules are very specific, so you would need to check on eligibility.

Of course, there has to be a complication. This provision only applies to the “current” 401k or 403b account for the current employer. 401k or 403b assets from prior employers are not eligible. If you have substantial savings in an older plan, it may make sense to roll it over into the current plan so they can be included. Definitely do your due diligence and consult your financial planner and/or accountant.

Another benefit of using the Rule of 55 is that it can reduce your Required Minimum Distributions (RMD) that apply when you turn age 72 and older for certain retirement accounts, like a 401k. This is another example of having “diversification” to provide flexibility. For example, we may try to use our 401k savings “early” in retirement, and retain our Roth IRAs for the later years, since a Roth IRA does not require RMDS. Diversification is a recurring theme and we are always learning and adjusting to manage our Financial Plan.

The Rule of 55 is fairly straightforward, but we would like to retire sooner! Too bad we weren’t public service employees, because age 50 would have worked better! We can look at other options, like Rule 72(t) in another article. Would love to hear from folks that have experience with the Rule of 55, how did it work out? Any caveats or other advice?

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~$Retirement Nerd🤓

Disclaimer: I am not a financial planner and content on this site is meant to provide food for thought, not professional advice. I share my experiences to show what worked so far and what didn’t, YMMV. Please consult your financial advisor or tax professional as needed.

By $Retirement Nerd

$Retirement Nerd is in his late 40s and looking to retire in the next few years.

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