Getting Your Financial Ducks In A Row Rotating Header Image

Downside to the Age 55 Rule for 401k

5 cents

Photo credit: jb

In other articles we’ve covered the Age 55 rule for 401k plans – where you’re allowed to withdraw money from your 401k penalty-free if you leave employment at or after age 55. But there’s a downside to the Age 55 rule that you need to know about. We’ll cover the downside today.

When you reach age 55 and leave employment, you may be looking to use your 401k plan as your source of income needs for a few coming years. Perhaps you plan to withdraw from the 401k until you reach age 59½, when you’ll have access to other deferred money, or maybe until you reach age 62 and start receiving Social Security.

But there could be a problem in your strategy. Your 401k administrator might only allow a one-time lump-sum withdrawal from the plan! Many plans have this restriction – the reasoning being that they see the plan primarily as an accumulation vehicle, and they do not want to be in the position of maintaining long-term distributions.

So, for example, Steve retires from his job at age 56, knowing that he can take withdrawals from his 401k plan without penalty. So when he maps this out, he needs approximately $50,000 from his 401k plan each year. He needs this amount until he reaches age 62, when he’ll start taking his Social Security and drawing his pension.

When Steve contacts the 401k administrator to set this up, he learns that the plan only allows a lump sum distribution! This means that Steve would have to take a distribution of $150,000 to get him to age 59½. Of course this would result in significantly more tax than Steve anticipated, but there’s not much else he could do, other than going back to work. (It should be noted that not all 401k plans have this restriction – many will allow multiple withdrawals, but many do restrict withdrawals to a one-time lump sum. Check with your plan administrator as you devise your strategy.)

If he rolls over the 401k plan to an IRA, the Age 55 rule no longer applies. However, Steve has another option that can help the overall tax situation, by staging his withdrawals.

Staging Withdrawals

If Steve took the entire lump sum of $150,000 from his 401k in one year (rolling over the rest of the account to an IRA), the tax would be approximately $32,070, since he’s single. If he was married, the tax would be approximately $23,778. But, since he only needs $50,000 in the first year, he could withdraw that $50,000 for a tax cost of approximately $5,940 ($3,448 if he was married). The remaining 401k would be rolled over into an IRA.

Then in the subsequent years, Steve could take “early” withdrawals of $50,000 each year, paying the 10% penalty. His total tax each of the two following years (his age 57 and 58) would work out to $10,940 per year (or $8,448 if he was married). So his total tax for the three years amounts to $27,820 – a savings of $4,250. If he was married the total tax would have been $20,344, saving $3,434 by staging. However, any way you look at it, this is costing an extra $10,000 in penalties, so it’s not the boon you thought it would be (if your plan is restricted like this).

Often, the best option to deal with this downside to the Age 55 rule is to come up with some other source of income during the intervening years. A part-time job could be the answer, helping Steve through the couple of years before he reaches age 59½. Or perhaps one of the other exceptions to early withdrawal could apply for a portion of his income needs. At age 59½ he could have the entire amount rolled over into an IRA and he’d have unfettered (unpenalized) access to the money in any amount.


  1. Eric says:

    Mr. Blankenship, I have a TSP/401k which consists of approximately 80% traditional IRA and 20% Roth IRA. Does the Rule of 55 also apply to the Roth portion of my TSP/401k? I retire at age 57 with the federal govt. Thank you.

    1. jblankenship says:

      I don’t know of any restrictions against the Roth component of your retirement account, so I assume the Age 55 Rule applies to it as well. You should confirm this with your account administrator, however.

  2. Paul Cullen says:

    I am 58 and looking to leave my current employer and I want to take the lump sum will I have to pay the penalty 10% ? After taking the lump sum can I put half into IRA and will I have to pay any tax on that money I put into IRA

    1. jblankenship says:

      You should fit into the post-55 withdrawal exception and should not have the 10% penalty on this withdrawal. Your IRA deposit will have to be accomplished within 60 days if you don’t rollover that amount directly to the IRA – that is, if you have the full amount distributed to you in the form of a check, you’ll have to finish the rollover within 60 days. You will owe tax on the remainder that is not rolled over.

      A better course of action would be to figure out how much you want to rollover into the IRA, and do this as a direct rollover, trustee-to-trustee. Then you can withdraw whatever is left as cash.

  3. Scott says:

    Does the rule of 55 apply to the the TSP as well? Also, if I go back to work with a different employer after I retire will that void the rule/cause me to have to pay the 10% penalty.

    1. jblankenship says:

      Although I don’t have any direct or anecdotal experience with this, it is my understanding that TSP has the age-55 option available just like all other employer plans.

      Going to work for another employer after leaving during the age 55 year has no impact on the rule’s applicability to the former employer’s plan. Rolling over the plan from the former employer’s plan to a new employer’s plan takes away the option (at least until you leave that subsequent employer). Rolling over into an IRA takes the option away altogether, unless you later rollover the IRA funds into another employer plan.

  4. Debbie says:

    I’m 53.5 and lost my job a couple months ago. I have several opportunities to return as an employee and contribute to the same 403b retirement plan that I’ve had for 20+ years. Can I have a separation from the employer/403b plan for a few months and then return to work and still use this Age 55 Rule? Would I need to be reemployed before the year I turn 55 (1/1/23) or just at any time during the year I turn 55? Could I take about a year off (starting at 53.5) and return to work at 54.5 and still use the Age 55 Rule?

    1. jblankenship says:

      As long as you’re employed and leave that employment sometime during or after the year that you reach age 55, this provision should apply to your case. Talk to your 401k administrator to make sure it’s going to work for you for sure.

  5. Mel says:

    If I turn 55 in October 2022, can I quit my job on January 1, 2022, since it is in the same calendar year?

    1. jblankenship says:

      Yes, that’s the way the rule works.

      If I were in your position I would talk to your 401(k) administrator to make sure they understand the rule, before you take for granted that you’re allowed this withdrawal without penalty.

  6. Brad Upton says:

    Thanks for answering everyone’s questions. I am sure you helped many. I plan on leaving this year. I am 55. 401K is $1.4 million and lump sum pension is around $800k. I plan on rolling over lump sum into the company’s 401k plan so I can touch it immediately in case it’s needed instead of rolling it into an IRA. Company’s plan manages the 401k at minimal to no cost depending on where funds are allocated. Some advisors mentioned I would have to take equal distributions until 59 1/2. Isn’t that the 72T rule?

    1. jblankenship says:

      Yes, that’s a 72t (or SOSEPP) arrangement, which is different from the age-55 rule.

  7. tom heiner says:

    I am considering utilizing the rule of 55 this year as I turn 55. One of my questions was if my emplyer allows equal distributions and I die before I turn 59 1/2, is my spouse (beneficiary) eligible to continue receiving those distributions and for how long?


    1. jblankenship says:

      If you have passed away, your spouse should be eligible to take distributions with the “death of primary owner” early distribution exception, so there should be no issues with continuing distribution.

  8. bryan says:

    Hello. If I were to take $40k a year from a 403b using this rule, I understand there is a mandatory 20% federal withholding. But if this were my only income, my tax bracket would be 12%. Would I expect a refund after filing, or has my tax bracket effectively become 20% regardless of total income?

    1. jblankenship says:

      The mandatory withholding has no effect on the actual tax that you pay. If your tax turns out to be something less than what was withheld, then you’ll get a refund of the difference when you file the tax return.

  9. Greg says:

    Is there a difference in the “55 Rule” and 72t? Do they both use the same 3 calculators for determining SEPP?

    1. jblankenship says:

      These are two different rules completely. The Age 55 Rule allows you to take any amount at any time with no penalty if you’ve left employment on or after the year that you’ll reach age 55. The classic 72t rule requires you to take a specific amount each year for the longer of 1) five years or 2) when you reach age 59 1/2.

  10. Tom says:

    If I leave my employer at 55 (or later) and begin drawing from my 401K under the 55 rule, what happens if I go back for 3 months each year? Can I withdraw when I’m not working, and not withdraw when I am? Would I have to pay a penalty if I’ve taken money (not working), and then go back in the same year? I intend to retire, but my company is asking if I can go back for a few months over the next few years. I don’t mind helping them out (and reducing the amount I take out of my 401K), but I don’t want it to cost me in the form of penalties, or the inability to start withdrawing again.

    1. jblankenship says:

      Most likely in a situation like what you’ve described, your employer would not consider you a full-time employee for the interim periods each year. Without full-time employee status, you probably wouldn’t be allowed to make contributions to the 401(k) plan.

      If I’m way off on this, then I don’t know the answer to your question. My gut instinct is that you would be eligible for the penalty-free withdrawals during any time that you’re not employed by the employer and you’re over age 55. But confirm this with your plan administrator, don’t just take my word for it.

  11. Janette says:


    My husband turned 57 and his employer allows multiple withdrawals so no worries there. My question is, how does the IRS know not to penalize the withdrawals? Is that automatic? Or do I have to indicate that when I file taxes?

    1. jblankenship says:

      The 1099R that is received in January of the following year should have a code 2 in box 7. Code 2 indicates “Early Distribution, Exception Applies”. If it is not coded correctly, there will be a penalty applied unless you contact the plan administrator to issue a corrected form.

      1. Chuck says:

        Hello Jim- Are there any restrictions regarding subsequent employment following a 401k age-55 withdrawal? If you are fired from your job, and you take a penalty-free 401k distribution at age 56 for example, are you prevented from working until you hit age 59 1/2? If you do find another job, would you have to pay the 10% penalty on that early withdrawal? Thanks?

        1. jblankenship says:

          No – the only restriction is that you have left employment at the job where the 401k is administered. If you return to work at the same employer and are eligible for participation in the 401k, the age-55 rule no longer applies to you. Any other employment has no impact on the age-55 rule from a former employer.

          1. Dave Mac says:

            Am I reading this correctly? If I return to the former employer (the one who administers your 403b early payouts) on a basis where I’m ineligible to participate in the 403b anymore (like part time work), then I’d still be fine with the age 55 rule and can take early withdrawals? No 10% early withdrawal penalties?

          2. jblankenship says:

            Check with the plan administrator, but in general that’s my understanding of the rules. Since you’ve left employment you’re allowed the early (age 55) no-penalty withdrawal. When you return as a part-timer you’re not (I assume) eligible for participation in the 403(b) because of your part-time status, so there’s no impact on your exception to the early withdrawal rule.

          3. Jenny says:

            Hi Jim- Do you know if I can leave my current employer at 55 and take advantage of the ‘Rule of 55’ and then go back to work for an old (different) employer (where I had previously contributed to and still have a 401k) and resume my participation in that 401k and then leave that company at age 56 and be able to use the ‘Rule of 55’ from both plans? Thanks

          4. jblankenship says:

            Assuming that both plan administrators allow it (which you’ll want to check on), your strategy should work.

  12. Darlene says:

    My company was recently acquired and will be closing down. The 401k plan will of course be terminated at close. I am over 55 and was looking to take advantage of the 55 rule to get me through should I need it. However, the acquiring organization will not be carrying the plan, which means I have to get the money rolled over. The way the rule works makes me think I won’t be able to get at my 401k without penalty. Is that true or are there circumstances to help in the case of plan termination?

    1. jblankenship says:

      Unfortunately, if the plan ceases to exist you’ll be limited to a single withdrawal when the plan closes (to avoid penalty). So in your case, you might be able to withdraw some of your funds penalty-free, but longer-term you’ll need to rollover these funds to another plan or IRA, which would eliminate your ability to utilize the age-55 rule. If the plan stays active, just not accepting new money, you should continue to have the ability to withdraw funds to avoid penalty.

      1. Darlene says:

        Thank you!

  13. Dave Perry says:

    Hi, Quick question. I will turn age 55 in 2020. I’m fortunate to have a large 401k balance and would like to start taking penalty-free distributions after I separate/retire in 2020. Fidelity runs the plan so no worries there, I won’t roll the balance anywhere. My question: Does anything change to my withdrawal options if I take a hobby-job that has access to a retirement plan at some future point?

    1. jblankenship says:

      No, your access to the 401k from that particular employer is locked in if you leave the employer on or after your 55th birthday. You can start a new job (with a 401k) the next day if you want to, and it will not change your ability to access the plan funds. You’ll need to make sure that the plan administrator allows you to take penalty-free distributions on a regular basis: some only allow a one-time distribution prior to age 59 1/2.

      1. Dave Perry says:

        Thank you sir! I will triple check but, I’m pretty sure I’m okay on multiple distributions from the plan. Speaking of triple checking, my 55th birthday is in July 2020 but if I separate in January of the same year, I’m still good. Correct?
        Thanks again

        1. jblankenship says:

          Yes, it is my understanding that this is allowed if you separate from service at any time during the calendar year of your 55th birthday.

  14. Cassy Johnson says:

    I will be 59.5 on 122618. I was laid off indefinitely in 2010@ 51yrs old -will I avoid the IRS 10% penalty if I withdraw from my 401k with my old employer ?

    Also, the 59..5 rule-is it 180 days after you’ve turned 59.5 that there’s no penalty?

    1. jblankenship says:

      If you are 59 1/2 years old, you will not be penalized on a withdrawal from a 401k account.

      59 1/2 is six months (not 180 days) after your 59th birthday. So, if born on June 26, 1959, you would be 59 1/2 years old on December 26, 2018.

  15. Bethany M Roberts says:

    My previous employer shut down operations in 2016 when I was 53 years old. While I move a substantial amount of my investment to an IRA, I left close to $60k in that 401k. I will be turning 55 this year and wish to ‘retire’. Does the 55 Rule apply to me in relation to my previous employment’s 401k? I would like to start receiving distributions.

    1. jblankenship says:

      No, since your former employment ended at your age 53, this is prior to age 55, so the age 55 rule will not apply to this account. Your option at this point would mostly be the 72(t) Series of Substantially-Equal Periodic Payments (SOSEPP) in order to avoid the penalty.

  16. beavatron says:

    Scenario: The company has declared the 401k plan closed to further contributions, and employees must decide whether and where to roll their balances to. The company is also closing in a few weeks. Since I am over 55, can I take a distribution as I rollover the majority of the 401k balance, without penalty? The technicality of the timing for when the separation of service (in IRS parlance) occurs vs. the rollover is unclear to me. Any advice on where to get an answer would be appreciated.

    1. jblankenship says:

      If you’re leaving the company/the plan is closing, since you’re over age 55 any distribution will be penalty-free. You’ll owe tax on the distribution, but no penalty. Just make sure you take the distribution from the 401k, not after you’ve rolled over to an IRA. If you rollover money to the IRA first, you are not allowed to take any money from the IRA penalty-free until you reach 59 1/2.

      1. beavatron says:

        Thanks for your reply. I definitely will take the distribution from the 401k. Happy to have confirmation that separation of service can take place after I do the distribution & rollover.

        1. jblankenship says:

          I did not confirm that you can separate from service after the distribution and rollover. In order to do the distribution without penalty, you must have separated from service first. Apologies if that was not clear in my reply.

          1. v538 says:

            If the plan is terminated but I am still working there for 4 more months, can I avoid the penalty based on the 55 yr old rule?

          2. jblankenship says:

            Only once you’ve left employment at the company – from the way I understand the rule.

  17. Ray says:

    My company dose participate in the rule 55 401k plan my question is what would be the maximum amount I could withdraw a year

    would it be the same maximum amount you could take out as a loan of 50k

    I really only need around 40K until 59.1/2

    1. jblankenship says:

      The maximum is going to be something your plan administrator can tell you about. There is no legal maximum in the Internal Revenue Code.

      1. Matthew M Hylland says:

        Are you sure about this?
        From the IRS website: “The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.”

        1. jblankenship says:


          The information you’re referring to is about a 401k loan. I’m referring to a withdrawal of funds from the 401k, which is allowed without penalty if you leave the employer at or after age 55. Otherwise (if you left the employer before age 55) you have access without penalty when you’re at least 59 1/2 years old.

          1. Matt Hylland says:

            Oops, yep sorry for the confusion. Thanks!

          2. jblankenship says:

            No problem – glad to clarify when it’s not clear at first.

  18. Theresa says:

    My situation is I took a loan in 2015 but before I could pay it back I went on permanent disability (stage 4 Mets Breast Cancer to bone). Loan just sat with no further payments and I didn’t need to draw on it with disability and social security. Now it’s 2018 and I received a call that the company I worked for when I was employed has merged with another company and they are closing the 401k plan and going elsewhere. Now I need to move my plan into an IRA but my loan needs to be claimed on taxes – it’s $30k. My questions Can I get the loan income without penalty? Can I get an extra 2k for cushion and can the rest be rolled into IRA without penalty and tax? I’m on limited income and they wouldn’t let me divide between 2 years for taxes and I have to do all this within the next few months. I took loan at age 53, left just short of 55 and now I’m 56.

    1. jblankenship says:

      Unfortunately you’ll likely have a penalty on the distribution, since you were under age 55 when you left the company. It’s possible you might get the age 55 exception if you left during the calendar year you were going to reach age 55, so you should contact the company administering the 401k plan to determine how they will code the distribution. The same would go for any additional distribution that you might want (beyond the loan) that is not to be rolled over into an IRA.

      1. Steve Dupree says:

        Does that mean that you could take a loan at age 54 or earlier, get terminated in the year you turn 55, let the loan lapse, and get it counted as a Rule of 55 penalty free withdrawal?

        1. jblankenship says:

          I think so. Of course, don’t take my word as gospel on this. I suggest asking a tax attorney about it, or the IRS, to be certain.

  19. Sharon says:

    One topic that I have not seen addressed in any articles on the Age 55 rule — can you quit/cease working for your current employer that holds your 401k, and then be re-hired by the same company while taking equal distributions under this rule?

    1. jblankenship says:

      I doubt it, unless you are re-hired under a classification that is not allowed access to the 401k plan. Even then, it’s apparent that you are gaming the system with this set of actions – I would not advise it.

      1. Dave Mac says:

        Jim/others – Please clarify if you can…If you “separate” from your employer at age 55 with a 403B and begin withdrawals that year, can you return to that same employer part time (with no access to the 403B since part time status) and not be be hit with 10% early withdrawal penalty? Is it the “separation” or the “no access to 403B” that determines penalties once you begin withdrawals? I’m not looking to game anything, just add to income with part time work. I’m a teacher, will retire at 55 and begin withdrawals, but will substitute teach part time for added income. I will not eligible to contribute to the 403B as a part time employee. Can I substitute for the same school where I “separated,” or not? Of course, I could substitute elsewhere, but I would prefer to do it at my current school. Like others, I’m just not finding an answer to the specifics of this.

        1. jblankenship says:

          If you’re no longer participating in the plan and aren’t eligible to participate (since you’re part-time?) then this withdrawal exception should work for you with no problem.

  20. JoeTaxpayer says:

    Just add this to the list of awful things about the tax code. We we retired, my wife was over 55, and this helped us bridge the gap to her turning 59-1/2.
    How awful it would have been when we were let go (and timing was perfect, that fired turned into retired) had we not been able to do this. Fortunately, this is behind us.

  21. Paul M Stifel says:

    It seems like the ‘substantially equal payments’ option might also work. Not knowing the balances in the deferred accounts, I can’t tell whether the RMD table amounts would be enough; and they have to go on for 5 years, so he’d have to deal with the Social Security overlap–perhaps by delaying SS and getting more later. If the RMD table amount was not enough, (and there were no non-deferred savings to draw on) I’d consider borrowing against my house to make up the difference, repaying either from the excess once SS started or via a IRA withdrawal once he reached 59.5. Any of these options would seem to be cheaper than paying big penalties or big taxes for lump sum options.

    1. jblankenship says:

      The amount in the account is exactly the problem, Paul. You bring up a great point, that the SOSEPP could help, but it’s unlikely that the balance would support the size of payment he’s looking for.

      Thanks for reaching out – it’s a great point to include…

Get involved!

Discover more from Getting Your Financial Ducks In A Row

Subscribe now to keep reading and get access to the full archive.

Continue reading