What is the rule of 55?

5 mins readLast updated October 4, 2023by Rachel Carey

Here’s how the rule of 55 can help you retire early.

How does the rule of 55 help you retire?

The IRS makes it harder for people to access their tax-advantaged retirement funds before the age of 59 years and six months. If you do, you could be hit with a 10 percent early withdrawal tax penalty and face additional taxes on the balance.

The penalty is designed to deter people from using their retirement savings for other purposes and being left with nothing for their later years. Unfortunately, using your 401(k) funds early can also stop you from being eligible for Social Security. But there’s a way to avoid the tax penalty legally and start using your retirement fund as early as 55 – or even 50 in some cases.

What is the rule of 55?

The rule of 55 is a legal but little-known loophole that allows you to withdraw from your pension funds from age 55 and retire early. Crucially, you won’t incur the ten percent tax penalty and can enjoy the entirety of your funds. If you’re fired, laid off, or choose to leave your job during the calendar year of your 55th birthday, you can begin withdrawing funds from your 401(k) or 403(b) for public service workers. Again, you won’t have to pay the penalty tax, which is ten percent of the value of your fund.

How does the rule of 55 work?

Those that choose not to find another job after 55 can start using their retirement funds if their provider allows. You must withdraw from a workplace pension – 401(k) or 403(b) – and not an IRA, as the rule of 55 does not apply to personal retirement accounts. Some people need to access the funds after unexpectedly losing their job, while others feel they have enough in their funds to retire early.

The beauty of the rule of 55 is that it doesn’t prevent you from returning to work at a later date. You may choose to retire at 55 due to ill health or to enjoy a career break. But you can return to work once you recover or if you’d like to start working again.

How much can I withdraw using the rule of 55?

The amount you can withdraw using the rule of 55 depends on your employer’s plan. Some may stipulate that amount pre-59.5 or even pre-62 withdrawals must be taken as a lump sum. Others will let you be flexible and set the level of withdrawal you’d like.

It's important to understand how much income tax you’ll need to pay on any 401(k) withdrawals. While the rule of 55 helps you avoid the ten percent penalty, it doesn’t cancel out the regular income taxes applied to money taken from a 401(k). So if you’ve left a high-paying job at 55, it may make sense to wait until the next tax year to begin your 401(k) withdrawals to reduce your tax bill.

Can I claim from previous 401(k)s using the rule of 55?

No – but if you’re approaching retirement and are considering using the rule of 55, there’s a legal way to overcome this.

If you have a direct 401(k), you can roll the funds into your new employer’s plan without penalties. First, however, it's best to contact your old plan’s administrator, who can help you roll your previous 401(k) into your new one and let you reap the full benefits of the rule of 55.

Should I retire early?

Retiring could make sense if you’ve been made redundant or fired after 55, and are confident you have plenty of funds to live for an average of 24 more years. However, it’s important to know that while the rule of 55 protects you from tax penalties, it doesn’t mitigate other downsides of early retirement.

If you retire before 62, you’ll receive no income at all from Social Security. And if you stop working after 62 but before your full retirement age, which is between 66 and 67, depending on the year you were born, you’ll receive 70–75 percent of your federal retirement benefit. Retiring early can also make health insurance more expensive and limit your access to Medicaid.

You must have another way to support yourself, like an annuity policy, investments that pay regular dividends, savings, or assets like property that you can convert into cash. Otherwise, your 401(k) may run out, and you’ll be left with no option but to claim state support.

Can I claim the rule of 55 before my 55th birthday?

Yes – but make sure you don’t misinterpret this caveat.

Some people believe they can leave their job the year before they turn 55 and withdraw from their pension just after their 54th birthday. In reality, the rule of 55 specifies you can only claim your 401(k) without penalty if you leave your job in the same calendar year as your 55th birthday. It doesn’t matter if you were born in January or December—if you turn 55 in 2023, you can retire using the rule of 55 in 2023.

Does the rule of 55 always apply?

Not always. Your employer has no legal obligation to let you withdraw funds early, and they may only allow you to take it in one lump sum, causing an income tax headache. You can also only take funds from your most recent 401(k) or 403(b) account. If you work for a private company, you must be in the calendar year of your 55th birthday. If you’re a public service employee, you can use your retirement funds without penalty from age 50.

Senior Content Writer

Rachel Carey

Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.