What Is the Rule of 55?

When it comes to saving for retirement, many people rely on employer-sponsored retirement accounts like 401(k)s and 403(b)s. Not only do they provide you with tax benefits, but they also make it possible for your employer to make additional contributions on your behalf—both of which can really bolster your ability to save for retirement.

One downside is: The money you contribute to these accounts is typically difficult to access until you reach retirement age, which the IRS currently defines as being 59½ years old. If you withdraw from these accounts earlier than that, the funds are subject to a 10 percent withdrawal penalty as well as income taxes, which can take a significant bite out of your savings.

However, there are some cases when it may be possible to tap some of your retirement funds early, thanks to the rule of 55.

Below, we take a look at what the rule of 55 is, how it works and the conditions you must meet to leverage it. We also discuss the potential drawbacks of withdrawing from your retirement accounts early so that you can make more informed decisions as you manage your savings.

What is the rule of 55?

The rule of 55 is an IRS provision that allows employees that meet certain conditions to access funds in a retirement account tied to their most recent employer before they reach full retirement age. It gets its name from the fact that it applies to workers who leave their employer, for any reason, in or after the year in which they turn 55.

How does the rule of 55 work?

If you have a retirement account through your employer, like a 401(k) or 403(b), and you stop working for that employer for any reason during or after the calendar year in which you turn 55 years old, you can withdraw funds penalty-free from the retirement account offered by that employer.

That means that whether you’re fired, laid off or simply quit on your own, it’s possible to access some of your retirement savings before you turn 59½.

But there are limits to this rule.

It only applies to your most recent employer

You can only use the rule of 55 to access funds held in a 401(k) or 403(b) sponsored by your most recent employer—i.e., the employer that you are leaving/have left. Retirement savings held in accounts sponsored by past employers cannot be accessed in this way (unless they’ve been rolled into your 401(k) with your current employer).

But, leveraging the rule of 55 doesn’t mean that you can’t then go out and find a new job. Once you meet the age requirement, you can access funds in a retirement account eligible for the rule of 55 regardless of whether or not you find another job and begin working again.

Employers are not required to follow the rule of 55

Not all retirement plans allow for early withdrawals, even if you are eligible for the rule of 55. You’ll need to check with your employer or plan administrator to be certain whether or not your plan allows for them.

It doesn’t mean you avoid paying taxes

The rule of 55 will only help you avoid paying the 10 percent early withdrawal fee. You will still be required to pay income taxes on the withdrawals. Exactly how much will depend on your current tax bracket, as well as whether the funds were invested through a traditional or Roth account.

It doesn’t apply if you left your job before age 55

To access the rule, you must leave your job during or after the calendar year in which you turn 55. If you leave your job before the calendar year in which you turn 55, you can’t then use the rule of 55 once you turn 55.

It doesn’t apply to money held in an IRA

The rule of 55 only applies to money held in a 401(k) or 403(b). It specifically does not apply to money held in an IRA, even if the IRA is through your employer. That means that if you leave your employer and then conduct an IRA rollover, you’ll no longer have access to the funds.

Rule of 55 pros and cons

Before deciding whether or not to take advantage of the rule of 55, it’s important to weigh its potential benefits against its disadvantages.

What are the benefits of the rule of 55?

No early withdrawal penalty

As noted above, using the rule of 55 allows you to tap into your retirement savings without paying the 10 percent early withdrawal penalty, giving you access to funds without losing savings. (Though you will still have to pay income tax on the withdrawals.)

You can keep working

Just because you withdraw funds from your 401(k) using the rule of 55 doesn’t mean that you can’t get a job and continue working. In fact, the rule of 55 might even help you weather a period of unexpected unemployment while you search for a new job.

Additional access to funds

While there is no replacement for a well-stocked emergency fund, having access to some of your retirement savings through the rule of 55 can provide you with some additional liquidity and peace of mind in the case of an emergency.

What are the pitfalls of the rule of 55?

You won’t avoid income taxes

While the rule of 55 helps you avoid an early withdrawal penalty, it doesn’t help you avoid income taxes. Depending on your tax bracket and how much income you’ve earned during the year, you may find yourself owing significantly more in taxes by taking an early withdrawal than if you were to wait until full retirement age.

And if you’re not strategic with when you take your withdrawal, you may find yourself in a higher tax bracket for the year than you anticipated. This can be especially tricky in cases where you worked for a portion of the year before making a withdrawal. It’s also important to be aware that some retirement plans require you to take a lump sum distribution if you wish to access your money early, which can easily push you into a higher tax bracket.

You’re limited to your current employer’s retirement account

The rule of 55 only allows penalty-free early withdrawals from the retirement account offered by your most recent employer. 401(k)s and 403(b)s from previous employers are still off limits until you hit full retirement age. (Although, it is possible to get around this by rolling over old 401(k)s into your current employer’s plan before leaving your job.)

Lost growth opportunities

The earlier you begin taking withdrawals from a retirement account, the less time it has to compound and grow. Retiring even a few years early and relying on your savings to support you during this time can result in some substantial lost growth.

Should you access funds using the rule of 55?

There are many reasons you may want to access funds early. Perhaps you’re looking to cover a gap in employment, or maybe you’re thinking of retiring early.

Early retirement is a dream for many, but before you take the plunge it’s important to make sure that you’re ready for it. That means having a sense of what your expenses will be during retirement, what streams of income you’ll be living off of, your retirement income strategy and more.

It also means taking a look at the numbers to make sure that your savings and portfolio can provide you with the kind of retirement you envision for yourself. After all, the last thing you want to do is rush into retirement and then spend your golden years worrying about whether or not you are going to outlive your money.

If you’re looking for help with your retirement strategy, consider speaking with a Northwestern Mutual financial advisor. Our advisors can help you run scenarios under a variety of conditions to help you make informed decisions about how and when to retire, whether you’re early in your career or approaching retirement—or even looking to move your timeline up.

This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.