Editor’s Note: “The Rule of 55″ is the eighth part of this year’s ongoing series focusing on how to retire early and the FIRE (Financial Independence, Retire Early) movement. Part 1 is how to retire early in 6 steps. A recent article is “5 Mistakes to Avoid When Retiring Early.” To see all our articles on early retirement, please visit the ‘Read more’ section at the bottom of this page.
The children may actually be okay. Today’s young professionals seem to be taking retirement more seriously than ever before. According to research from Northwestern Mutual, the average Gen Z and Millennial retire in their 20s, compared to Gen I’m starting to save for later.
While having access to more personal financial advice is certainly helpful, a key motivator is the desire to retire early. According to a YouGov poll, 30% of millennials expect to retire between the ages of 51 and 60.
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why are you in a hurry? Just like the workplace and career paths, younger generations are redefining retirement. According to a report from Edelman Financial Engines, nearly 4 in 10 Americans want a different retirement lifestyle than previous generations, with many pursuing an “active” and “adventurous” lifestyle. I understand that it is a priority.
By retiring early, you are more likely to be healthy enough to pursue activities such as traveling abroad or volunteering.
However, there are pitfalls for those considering early retirement. Funds in a 401(k) or similar tax-deferred plan generally cannot be accessed without penalty until age 59 1/2.
This is where the Rule of 55 comes in handy. This allows you to start taking distributions a little earlier without any 401(k) penalties. Here’s how this works and how it can help you fund early retirement.
What is the rule of 55?
The 55-year-old rule is an IRS provision that allows you to withdraw money from your 401(k) or other qualified retirement plan without the 10% early withdrawal penalty if you quit your job after the year you turn 55.
This can be a valuable tool for people who want to retire early but don’t want to incur a steep penalty for accessing their savings.
Additionally, Joli Fridman, CFP, CPA/PFS, and Wealth Advisor at Buckingham Strategic Wealth, says it’s beneficial for “employees who retire early for health reasons, job loss, or other reasons.” Pointed out.
How the Rule of 55 works
To qualify, you must quit your job voluntarily or involuntarily after the year you turn 55.
Fridman emphasizes that “this rule only applies to recent employer 401(k) plans.” This means you should keep your money in other retirement accounts until you reach age 59 1/2 if you want to avoid early withdrawal penalties.
“If you roll the funds over to an IRA or new employer plan, you can no longer use the 55 rule,” adds John Chapman, CFP® at Worthpoint Wealth Management.
For example, if you quit your job at age 55 and put your funds in your employer’s 401(k), you can start making withdrawals from that account without penalty. But if you roll these funds into an IRA, you’ll have to wait until age 59 1/2 to access them penalty-free.
This rule helps you avoid penalties, but it does not exempt you from paying taxes. Distributions received are taxed as ordinary income.
drawer plans
Before drawing on a 401(k) under the 55 Rule, Chapman recommends contacting the plan administrator to review the withdrawal rules and ensure that the date of separation is properly documented. Masu.
He also points out that once you start making withdrawals, your funds no longer benefit from future growth or compounding, which can affect your long-term retirement goals.
This strategy allows you to access your 401(k) without penalty, but it’s not a magic solution for early retirement. Chapman advises that investors need to maintain a solid financial foundation, including being debt-free and building a healthy emergency fund, before considering this option.
Consideration for early retirees
The 55-year-old rule can be a helpful tool if you’re planning to retire early, but experts warn it shouldn’t be your only strategy. For more flexibility, consider having multiple sources of income, such as a non-retirement brokerage account or cash savings, which allow penalty-free withdrawals at any age. When it comes to early retirement income, you need to plan for the long term, not just the first few years of retirement.
Chapman says, “One common mistake is relying too much on a 401(k) without other savings,” which leads to a situation where you are “401(k) rich but cash poor.” Your access to funds may be limited if you retire early. By making regular contributions to a brokerage account along with your 401(k), you can gain greater liquidity and flexibility in the future.
Special consideration should also be given to public safety personnel such as police officers, firefighters, EMTs, and air traffic controllers. Essentially, these workers are subject to the 55-year-old rule in the calendar year in which they turn 50.
Is the Rule of 55 right for you?
While the 55-year-old rule has unique benefits, it’s only “one piece of the retirement puzzle,” Chapman says.
Fridman said workers planning for early retirement still need to consider other important factors, such as when to claim Social Security, how to receive their pension, and how to efficiently withdraw money from investment accounts. he added. “The best strategy is to work with a financial advisor who can help you determine the best plan for your situation,” she advises.
After all, retiring early is not just about avoiding penalties, it’s about making your money last longer.
