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%. However, there’s a penalty-free way to take your distributions a few years early called the Rule of 55. If you’re contemplating an early retirement, it can help to know how the Rule of 55 works and when you can withdraw from a 401(k) without penalty.

A financial advisor can help you create a retirement plan to manage your long-term financial goals.

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% early withdrawal penalty if you leave that job in or after the year you turn 55. (Note that 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.

However, distributions are not completely tax-free. 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.

Employers are not obliged to allow early withdrawals, either. If they do allow them, they may require that you take 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 IRS 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. This also means you’ll have to pay for your living expenses and added expenses, such as health insurance. Using the Rule of 55 to take early withdrawals can help cover those costs.

To start making withdrawals, you must first prove to the plan administrator that you qualify. This is accomplished a few different ways:

Retirement age. You must leave your job during the calendar year you turn 55 or after to qualify for the Rule of 55. The IRS lowers this age requirement to 50 for public service employees.
Employment. You must leave your job to start taking withdrawals, but 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 year. 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 what if, at 58, you take a part-time job. The good news is that you can continue taking penalty-free distributions from that 401(k) plan. Of course, it must be the same plan you were contributing to when you resigned from your job.

There is one caveat to taking penalty-free withdrawals: You cannot have rolled your 401(k) into another plan or an IRA.

Click Your State to Get Matched With Financial Advisors That Serve Your Area

Choose your state and answer some questions to get matched with up to three fiduciary advisors that serve your area.

Tax Considerations and Withholding on Rule of 55 Withdrawals

A couple discussing the 401(k) Rule of 55 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. This 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. You can request otherwise or take substantially equal periodic payments instead. 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 how your state taxes 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 may 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. You can then structure a withdrawal plan that minimizes unexpected tax bills.

Being proactive about tax implications will help preserve more of your retirement savings and support a more predictable income stream in early retirement.

Alternatives to Rule of 55 Withdrawals

The Rule of 55 isn’t the only way to withdraw money from your retirement plan early.

There are several types of withdrawals that qualify for penalty-free early withdrawals from a 401(k):

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 program. If you take money from an employer’s plan, you must separate from service to qualify for this exception, but you’re not subject to the 55 or older requirement. The payout amounts are based on your life expectancy.

How Rollovers and Roths Affect Rule of 55 Withdrawals

The rule applies only to the 401(k) or 403(b) sponsored by the employer you leave in the year you turn 55 or later. And if you move that balance elsewhere, you may lose eligibility for penalty-free access.

If you roll your workplace plan into an IRA after leaving your job, the Rule of 55 no longer applies. IRAs follow the standard 59 ½ rule and do not offer an exception based on separation from service at age 55.

The same applies if you roll your balance into a new employer’s plan. Only money left in the original plan is eligible for penalty-free withdrawals.

Roth 401(k) and Roth 403(b) accounts follow different tax rules. Qualified distributions are tax-free, but nonqualified withdrawals may trigger taxes on earnings even if the Rule of 55 removes the early withdrawal penalty.

There are also five-year holding requirements that can affect the taxation of Roth withdrawals. Workers using the Rule of 55 often coordinate distributions to avoid unintentionally triggering taxes on Roth earnings.

Employer plan rules also matter. Some plans allow partial withdrawals, while others require a full distribution. Some restrict withdrawal frequency or impose administrative delays.

Reviewing the plan document or speaking with the plan administrator can help you understand how your specific plan handles Rule of 55 withdrawals before you separate from your employer.

How Could a Financial Advisor Help You Create an Early Retirement Plan

If you plan to retire before 59 ½ and expect to rely on the Rule of 55, advice can matter most at the point you separate from your employer. Your eligibility depends on the calendar year you leave work, the specific plan tied to that employer and whether the account balance stays in place. A misstep, such as rolling the account into an IRA too early, can remove penalty-free access.

Using the Rule of 55 involves decisions about timing, account structure and income sequencing. You must decide when to leave your job, whether to keep funds in the employer plan, how much to withdraw each year, and how withdrawals interact with wages, severance, bonuses, or part-time income. You also face plan-specific limits, such as lump-sum requirements or withdrawal frequency rules.

A financial advisor helps you evaluate how Rule of 55 withdrawals fit into a broader early retirement income plan. This includes projecting taxable income year by year, comparing withdrawals against taxable savings or Roth assets, and reviewing how health insurance costs affect cash flow before Medicare. The advisor can also review plan documents to clarify what distributions the employer allows.

Common Questions for your Advisor

You might ask questions such as: If I leave work in July of the year I turn 55, when can I start withdrawals? How much can I withdraw without pushing myself into a higher tax bracket? Should I delay Rule of 55 withdrawals until January to reduce total taxable income? What happens if I take a new job or need to roll part of the balance later?

The value of advice increases because Rule of 55 benefits hinge on narrow timing rules and limited account eligibility. Once the separation date passes or a rollover occurs, the option cannot be restored. A financial advisor helps you weigh the tradeoffs, coordinate withdrawals with taxes and avoid actions that permanently eliminate penalty-free access during early retirement.

Bottom Line

A clock, calculator, and money sitting on a desk.

The Rule of 55 allows you to take money from your employer’s retirement plan without a tax penalty before age 59 ½, 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. If you plan to retire early but 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!