The Rule of 55: The Overlooked Path to an Early Retirement
getty
A 2024 MassMutual poll of 2,000 Americans found that 67% of retirees were happier in retirement, while just 8% felt less happy. The study defined “retirees” as up to 15 years into retirement and “pre-retirees” as within 15 years of retiring. A 2023 Transamerica survey and a 2007 University of Michigan study both found that retirees often report greater happiness, life satisfaction, or lower stress than during their working years.
Happiness may be subjective, but with multiple studies suggesting retirement may improve quality of life, strategies that enable earlier access to savings, like the IRS’s underutilized rule of 55, deserve attention.
If retirement has the potential to enhance well-being, it seems worth the effort to identify any and all tools that may help individuals reach retirement sooner, rather than later.
getty
If retirement has the potential to enhance well-being, it seems worth the effort to identify any and all tools that may help individuals reach retirement sooner, rather than later. One of those tools is an early withdrawal penalty exemption in the tax code, commonly known as the rule of 55.
What Is The Rule Of 55?
This rule of thumb can be an effective mechanism and is perhaps underutilized because of its complex structure. Many individuals know 59½ marks the age for penalty-free withdrawals. However, fewer understand the operational playbook that kicks in at 55. According to IRS guidelines, if an employee loses their job or retires when they’ve reached age 55, but not yet turned 59½, they may qualify to take distributions from their 401(k), 403(b), or other qualified retirement plans without triggering the 10% early withdrawal penalty.
According to IRS guidelines, if an employee loses their job or retires when they’ve reached age 55, but not yet turned 59½, they may qualify to take distributions from their 401(k), 403(b), or other qualified retirement plans without triggering the 10% early withdrawal penalty.
getty
However, the fine print gets even finer. This exception only applies to the employee’s current or most recent retirement plan. Withdrawals from prior employer plans or IRAs remain subject to the 10% penalty, unless those assets were consolidated into the eligible account before employment ended.
Individuals planning for retirement typically pay attention to penalties. To revisit the earlier point, the simplicity of age 59½—when the 10% penalty ends—is far easier to recall than the layered requirements around age 55. Even those willing to pull out the magnifying glass may realize they moved money out of employer-based accounts and into IRAs before noting the exemption. However, if that is the case, not all hope is lost.
The Secret Weapon: A Reverse Rollover
A reverse rollover is a method for returning assets to a qualified retirement plan.
getty
A reverse rollover is a method for returning assets to a qualified retirement plan. Though a strategy most individuals, and even many advisors, tend to overlook, it can be a feasible maneuver for some to expand the penalty-free withdrawal pool. That said, not all employer-sponsored plans accept roll-ins, and eligibility depends on each plan’s specific rules.
Consider a scenario in which an employee left their job years ago and rolled that company’s retirement account into an IRA. Now 55 years old, this individual is planning for retirement with very little in their current one. What can be done?
Said employee may be able to roll some IRA funds back into the eligible account before ceasing employment, potentially qualifying the entire balance for the rule of 55 exemption. However, keep in mind certain parameters:
Private sector employee separation must occur in or after the calendar year the employee turns 55 to take distributions from their current 401(k) or 403(b) without the 10% early withdrawal penalty. Many public safety employees, such as police officers and firefighters, qualify at age 50 or younger. For instance, under the Federal Employees Retirement System (FERS), federal law enforcement officers (LEOs) can retire at age 50 with at least 20 years of service (CRS, Retirement Benefits for Federal Law Enforcement Personnel).
Many public safety employees, such as police officers and firefighters, qualify at age 50 or younger.
gettyThe reason why an employee separates does not typically affect eligibility. It can be voluntary, a layoff, or even early retirement. Previous retirement accounts such as 401(k)s and 403(b)s from prior employers do not qualify unless they were successfully rolled over prior to separation.Neither IRAs nor Roth IRAs qualify for the age 55 penalty exemption.Individuals eligible for the age 55 exemption remain subject to ordinary income tax.Many employee-based retirement plans allow partial withdrawals, but some do not. It’s typically a good idea for individuals to confirm with their plan administrator.Bottom Line
If retirement savings can be categorized into a four-bucket framework, the rule of 55 might fit into bucket two.
If retirement savings can be categorized into a four-bucket framework, the rule of 55 might fit into bucket two.
gettyBucket 1: Cash—emergency fund and short-term expenses.Bucket 2: Employer plans eligible for the rule of 55—accessible in the mid-to-late 50s.Bucket 3: Roth IRAs and brokerage accounts—flexible, tax-efficient funds.Bucket 4: Traditional IRA, 401(k), or 403(b)—for the 60s and beyond.
Viewed this way, the rule of 55 can potentially provide mid-career retirees with both flexibility and a strategic path to access savings sooner.
As a common benchmark, the rule of 55 bucket may be viewed as one of the IRS’s underrecognized opportunities. While the intricacies may make 55 a more intimidating rule of thumb, they do not diminish its significant potential upside. Equipping future retirees with the knowledge to leverage it can sometimes accelerate their retirement timeline. Individuals considering a workforce exit between age 55 and 59½ may benefit from further research before assuming they won’t qualify. Even those who have previously moved funds may want to speak with an advisor about reverse rollover options.
When planned thoughtfully, the rule of 55 may create breathing room, flexibility, and the ability to retire on a preferred timeline, rather than being dictated by prevailing assumptions and parameters.
This publication is provided for informational purposes only and should not be regarded as personalized investment advice. Investors should seek advice from a qualified financial advisor about their specific situation prior to implementing an investment strategy. The information provided is not an offer or solicitation of any product or service. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and is not suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision you may make. Always consult with your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.