401(k) Withdrawals: Use The Rule Of 55 To Avoid 401(K) Penalties

Whatever the reason, if it comes down to the withdrawal of the 401k retirement funds, you need to be ready to pay the penalty.

If you have been employed long enough and have been using either 403(k)s or 403(b)s for retirement investment, you must know about the penalties that come with early withdrawal.

When employees take out their investment from the 401(k), they usually have to pay a penalty of 10% of the fund on top of the income tax. However, if the employee follows the 401k withdrawal age, they do not have to pay the penalties.

However, employees can still opt for what is called the rule of 55. Go through this article to learn more about the 401k withdrawal age; also, how the rule of 55 can help you avoid penalties.

At What Age Is 401k Withdrawal Tax-Free?

The federal government has set the required minimum distribution for 401k withdrawals. If employees want to withdraw their 401K funds without paying any taxes, they need to follow the RMDs.

According to this RMD, the employee must withdraw the 401 k fund after turning 59½. This is for the early withdrawal penalty of 10% of the fund. However, for tax-free 401k withdrawal, the employees need to be 72 years old before they withdraw the funds.

However, there are some exceptions to these rules. In case of layoffs, or permanent disabilities, employees can avoid their penalties. Also, exceptions can be made in terms of the plan 401k plan you have. So, ‘if your question is what age can you take out 401k?’ I guess you have your answer.

Regarding RMD and details of the 401(K) investments, you can go through our 101 guide to 401k.

What Is The Early Withdrawal Penalty For 401k?

When an employee withdraws 401(k) before the age of 59 and ½ years, then the IRS can assess a 10% tax as a penalty for early withdrawal. So, when withdrawing money before the age of 59 and ½ from the 401 (K) funds, the employee ends up paying a penalty of 10% on top of the income tax gathered by the fund.

So, if the employee is withdrawing a $10,000 check from their 401(k) funds, they will end up giving $1000 to the government. In addition to this penalty, the employees also have to pay a 10% ordinary tax. So, in the end, they will end up taking as little as $7000 home from the amount they wanted to withdraw from their 401 K funds.

In light of this calculation, it is a loss on the employee’s part to take out their fund before they are 59 and ½ years old. But there are workarounds that one can follow.

What Is The Rule Of 55?

Aside from the rules in the RMDs, the employees must also know some safety getaways. There is this rule called the rule of 55. Under this rule, the employees can take out their funds without paying the 10% penalty. This means that you are getting the tax benefits of investing in the 401k while also taking your money as early as 55 years of age.

The rule of 55 applies to the employees irrespective of the fact that they quit, were fired, or were laid off. They can avoid the 10% penalty that comes with the early withdrawal as soon as they turn 55 and leave their job.

However, this withdrawal is not completely tax-free. The employee needs to pay the 10% tax they need to originally paid. 401(K) or 403 (b) taxpayers can only bypass 10% of their tax penalty under the rule of 55. After that, they can transfer their 401k funds to their new employers’ plans without being worried about their 401k withdrawal age.

But, if employees want to use the benefit of the rule of 55, they need to use it on their current account. The federal government does not allow the rule of 55 on the 401K plans of one’s previous employer. In that case, employees still need to pay the tax penalties. But, they can avoid that by transferring their current 401k plans.

How To Use Rule Of 55 To Avoid Tax Penalties?

The rule of 55 is one of the best options for people planning an early retirement. When someone considers an early retirement, they will have access to their social security benefits. This means the employee must pay for their health insurance and living expenses.

But unless they have a lot of money in their savings and other check-in accounts, then the rule of 55 is the only viable option. Here is how you want to proceed.

Retirement Age

Ensure that you are retiring a day after you turn 55. It is crucial to leave your job after turning 55 to avail the rule of 55. But, if you are a public service employee, you can retire as early as 50. If you are not a public service employee and you are retiring earlier than 55, then you will not be able to benefit from the rule.

You Can Work

If you want to avoid an early penalty that comes with the 401k withdrawal age (if done before 59 and ½ years), you have to leave work and retire. That does not mean you cannot work later. You can also get employed after you retire and have taken out your 401k funds.

Retirement Account 

Also, employees need to remember to withdraw from their recent 401(k) or 403(b) funds if they want the rule of 55 to work.

Bottom Line

Employees or working professionals with a 401k fund usually look for ways to avoid their income taxes. Following the rule of 55 can help them avoid the 401k withdrawal age that results in penalties. But they cannot avoid the general tax. That would require them to withdraw the fund after the employee has turned 72 years old or more.

I hope that this article provides you with the necessary information on the 401K withdrawal age. Please let us know about your feedback on the same.

Read Also:

• Form 940 – How To File? And Is It Important?
• Form 944, Employer’s Annual Federal Tax Return
• What Happens To Your 401k When You Leave A Job?