Can I Use the Rule of 55 and Still Work?

The Rule of 55 is an Internal Revenue Service (IRS) provision that allows individuals to access funds from their employer-sponsored retirement plans without incurring the typical 10% early withdrawal penalty. This rule is particularly relevant for those contemplating early retirement or facing unexpected job loss before the standard retirement age of 59½. It provides a specific exception for certain circumstances, but understanding who qualifies and how continued employment might affect eligibility is crucial.

Understanding the Rule of 55

The Rule of 55 permits penalty-free withdrawals from employer-sponsored retirement plans, such as 401(k)s and 403(b)s. This applies if an individual separates from service with their employer in or after the calendar year they turn 55. The age requirement is lowered to 50 for qualified public safety employees, including police officers, firefighters, and EMTs.

This rule specifically applies to the retirement plan of the employer from whom you separated. It generally does not extend to Individual Retirement Accounts (IRAs), whether traditional or Roth, unless the funds were directly rolled over from a qualifying employer plan. If funds from a 401(k) are rolled into an IRA, they lose the Rule of 55 protection, and withdrawals before 59½ would be subject to the 10% penalty unless another exception applies. The rule’s intent is to offer financial flexibility for those who leave their employment closer to traditional retirement age but still need access to their savings.

The “Separation from Service” Requirement and Working

The “separation from service” requirement is a central component of the Rule of 55. This means you must have left the employment of the employer sponsoring the retirement plan you wish to access. This separation must occur in or after the calendar year you attain age 55 (or age 50 for eligible public safety workers), regardless of whether it’s due to quitting, being laid off, or retirement.

If an individual wishes to continue working for the same employer whose 401(k) or 403(b) plan they want to access, the Rule of 55 does not apply to that plan’s funds. The rule permits penalty-free withdrawals only after a qualifying separation from that specific employer.

After a qualified separation from service, an individual can take on a new job with a different employer or become self-employed and still make penalty-free withdrawals from the previous employer’s plan under the Rule of 55. The funds must remain in the former employer’s plan; rolling them into a new employer’s plan or an IRA would negate the Rule of 55 benefit for those specific funds. Re-employment with the same former employer could complicate or invalidate future withdrawals under the Rule of 55, as it might negate the initial “separation from service” condition.

Key Considerations for Rule of 55 Withdrawals

While the Rule of 55 waives the 10% early withdrawal penalty, withdrawals are still subject to ordinary income tax. These funds are treated as taxable income in the year they are withdrawn, potentially impacting your overall tax bracket. Plan administrators are generally required to withhold 20% of each withdrawal for federal income tax, unless otherwise requested or if substantially equal periodic payments are taken.

The Rule of 55 does not apply to IRAs. For IRA withdrawals before age 59½, other IRS provisions like Substantially Equal Periodic Payments (SEPP) under Internal Revenue Code Section 72 may be considered. These SEPP rules involve a strict schedule of withdrawals based on life expectancy and apply to a broader range of retirement accounts, including IRAs. Unlike the Rule of 55, which offers flexibility in withdrawal amounts, SEPP requires consistent, predetermined payments.

Even if an individual meets the IRS criteria for the Rule of 55, some employer plans may have their own specific rules regarding in-service withdrawals or the timing of distributions. It is advisable to review the Summary Plan Description or contact the plan administrator to confirm whether the Rule of 55 is permitted and to understand any specific plan limitations. Careful financial planning is important before utilizing the Rule of 55, as early withdrawals can reduce the long-term growth potential of retirement savings.