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The rule of 55 lets you tap into your 401(k) early without paying a penalty, but only if you meet the age requirement and other terms


rule of 55

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It’s easy enough to contribute to a 401(k) or 403(b) plan. But getting your money back out of these workplace retirement accounts can be more difficult. Unless you’re at least 59½ years old, it usually triggers taxes and penalties. 

But those who have reached the age of 55 have a special option to access their funds penalty-free. This “rule of 55” could save serious money if you want to retire early or need to make a one-time withdrawal from your plan to cover a major expense.

What is the rule of 55?

To discourage the use of retirement plan funds for non-retirement expenses, the IRS normally doesn’t allow you to withdraw from your 401(k) early — “early” being defined as before age 59½. 

If you do, you’re dinged with income taxes — an automatic 20% of the amount you take out — plus an additional 10% tax penalty.

But the IRS makes an exception for the middle-aged. It spares you the 10% penalty if you have parted ways with your employer and are over 55 years old. If you’re a public safety worker (police or corrections officer, fire fighter, EMS responder), you can be as young as 50.

The rule of 55, as it’s colloquially known, can apply whether you quit your job voluntarily or are fired. But the departure must happen after you reach the appropriate age. So if you retired at age 54, you wouldn’t be eligible for the rule of 55, even after your 55th birthday.

Bear in mind that the rule of 55 does not remove your income tax obligations on your 401(k) withdrawals — only the 10% penalty. With a traditional 401(k), that means you owe tax on any amount you take out. With a Roth 401(k), that means any earnings generated by the account, if you’ve held it for less than five years.

Limits of the rule of 55 

Of course, the IRS never makes anything simple. Here are key limitations to keep in mind with the rule of 55 and your eligibility:

It has to be a 401(k). One common misunderstanding with the rule of 55 is that it applies to all retirement accounts. But, in fact, IRAs are not eligible for this exception.

It only works with your current 401(k). So any money sitting in an account from an old job isn’t covered by the rule of 55.

It may not apply to your 401(k). While employers can allow early distributions (IRS-speak for withdrawals) to departing 55-year-old employees, they are not obligated to do so. So it’s crucial to ask your company’s 401(k) plan administrator if early withdrawals, and hence the rule of 55, are allowed. 

How to take advantage of the rule of 55

The rule of 55 could be a deciding factor for those who are considering early retirement. It also helps if you’ve been unexpectedly downsized, and need a sizable sum right away: to cover medical bills, or pay off your mortgage early. While it’s …read more

Source:: Business Insider

      

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