The rule of 55

How it works

The 10 percent addition on withdrawals before 59 and a half has a list of exceptions, and one of them covers distributions from a workplace plan after separation from service in or after the year the worker reaches 55. The age test is about the year of separation, so a worker who leaves in January of the year they turn 55 qualifies even before the birthday. It applies only to the plan of the employer the worker left at that age, not to an older plan from an earlier job and not to money rolled into an IRA, which loses this exception the moment it leaves the plan. The plan has to allow withdrawals after separation for this to be useful, and some plans allow only a full lump sum rather than partial withdrawals.

What it gives

A person who retires early from a job can draw on that plan without the 10 percent addition.

The year rule means a January separation counts the whole year a worker turns 55.

Income tax is the only cost, the same as a withdrawal at any later age.

What it costs, or where the catch is

Rolling the plan to an IRA ends the exception for that money.

Older plans from earlier employers do not qualify unless rolled into the current plan before leaving.

A plan that pays only lump sums forces the whole balance into one tax year.

A worked example

Greta leaves her employer in March of the year she turns 55 with $400,000 in its 401(k). She withdraws $30,000 that year. The 10 percent addition that would have cost $3,000 does not apply. She owes income tax of about $3,300 at a blended rate near 11 percent, and the plan withholds 20 percent, $6,000, up front, with the difference settled at filing. Her older 401(k) from a previous job does not get this treatment.

Where it goes wrong

The common miss is rolling the plan into an IRA right after leaving, out of habit, and then owing the 10 percent addition on every withdrawal until 59 and a half.

Who confirms it for you

For your own numbers, the plan administrator or HR. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.

The official source

IRS: Exceptions to tax on early distributions. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.