The Rule of 55

In the spirit of retiring early, there are several ways to go about it. We have spoken in the past about the importance of The 3 Bucket Strategy, as the after-tax bucket could be your income bridge to age 59-1/2. Other than simply loading up on your taxable brokerage account, there are other tactics to retire earlier than you may have thought possible.

What happens if you got laid off a few years before you were ready? What if you were only utilizing tax-deferred accounts for investing? You have all this money “locked up” in a 401k or 403b, but really don’t want to get hit with that 10% penalty? I mean… we are only really a few years away from retirement age anyway, do you really need to get another job?

Enter The Rule of 55!

Disclaimer: I am not a CFP, CPA, CFA, or tax professional of any kind. This post is intended for informative and entertainment purposes only. It is highly recommended that you consult with a financial advisor and/or tax professional before putting this method into action.

Believe it or not, the IRS is sometimes our friend! They tend to reward those who save and invest early and often. The Rule of 55 is an IRS guideline that allows you to withdraw from your retirement accounts (401k or 403b) earlier than 59-1/2. You can avoid the 10% early withdrawal penalty in the event of job loss or decide to retire early if it happens the same year you turn 55 or older.

What’s the kicker?

This rule only applies to the current employer sponsored plan from the organization you are currently working for or just left. Meaning that penalty free distributions can only happen on that specific 401k or 403b plan. Any separate IRA’s that you have in place or old 401k’s lying around from previous employers will not be applicable to The Rule of 55.

What kicks the kicker?

Technically speaking, you can roll over these old tax deferred retirement accounts into your existing 401k before departing the current company. If done so before the year you turn 55, those funds would qualify for penalty free distributions!

Yet another kicker?

If you decide to enact The Rule of 55, you can still go get yourself another job with another company if you choose to. This is especially fruitful for those looking to work part time or potentially start a business instead of fully retiring early. You just need to make sure that any withdrawals made come only from that original 401k or 403b to avoid penalty.

Withdrawals can fluctuate year to year: Unlike a similar retire early tactic, you are not forced to withdraw the same amount each year.

Great option for those looking to FILE: Instead of full on FIRE (Financial Independence/Retire Early), some of us Savvy Solos are looking to FILE (Financial Independence/Live Early). We can enact this rule and still pursue a passion project that brings in some level of income.

Worried about RMDs: Annual required minimum distributions begin in your 70s for many tax deferred retirement accounts. Based on your tax situation and size of the account, it may be beneficial to start withdrawals sooner than later.

Know the rules of your current plan: Some 401k’s and 403b’s do not offer partial withdrawals once you have left the company. A regular retiree would roll over the 401k into an IRA. This would then be qualified for a 10% early withdrawal penalty for a 55-year-old. Technically you could withdraw it all at once, but that would have hefty tax consequences.

Impact on growth potential: Depending on the size of your retirement portfolio, and your expected annual spend, early withdrawals could have a detrimental effect on the lifespan of your nest egg. Be sure to consult with a financial professional to ensure long-term financial security.

Roth considerations: Technically a Roth 401k can also be utilized under The Rule of 55. Like any Roth account, however, earnings may still be taxable due to the 5-year rule depending on the date of contributions. Probably best to avoid withdrawals from Roth accounts while using this method to avoid any additional taxes.

Don’t forget, even with The Rule of 55, you’ll still be paying regular income tax on withdrawals from tax-deferred accounts. This is why it’s still important to try to map out your 3 Bucket Strategy, even if you plan on utilizing this method. Nevertheless, this rule can be a powerful tactic depending on your situation.

This strategy is the most beneficial for those that had listened to the old advice of maxing out tax-deferred accounts before investing anywhere else and are now looking to retire a little early. I especially like this method for those aged 55-58 who are looking for a way to downgrade their income to upgrade their life. It’s also a good safety blanket in the event of job loss prior 59-1/2. Agism is very real, and very hard to prove!

Consider The Rule of 55 an extra tool on your toolbelt while building your best life. Best to have it and not need it, then need it and not have it. I don’t personally have this rule in my current financial plan, but I’m happy it’s there just in case!

Stay classy Solos! ✌️