How to Access Retirement Funds Before Age 59 1/2

The average retirement age in the U.S. falls in the early 60’s. That puts new retirees over the age where they can access their retirement funds without penalty (59 ½). For those who retire before that magical age, is there a way to access their retirement savings without penalties?

The Rule of 55

The rule of 55 is an IRA guideline that allows workers to avoid the 10% early withdrawal penalty for distributions from a 401(k) or 403(b) account. The rule applies to workers who leave their jobs during or after the year in which they turn 55. The circumstances surrounding the departure do not matter—a worker can get laid off, fired, or just quit their job and still be eligible.

There are some caveats. First, you may only withdraw money from your most recently active retirement plan, i.e. the plan at the company you just left. Old 401(k) or 403(b) plans and any IRA accounts are not eligible for the rule of 55 treatment. However, rolling old plans into your current plan before leaving would give you early access to those funds.

Second, your most recent employer’s plan must allow early withdrawals – this is not always the case! If you are retiring early, check the fine print on your current plan before walking out the door. Also, remember that your early withdrawals are still considered taxable income. The rule of 55 lets you avoid the additional penalty but not the standard taxation on withdrawals.

Substantially Equal Periodic Payment (SEPP)

Another method for accessing retirement funds before age 59 ½ without penalty is establishing a series of substantially equal periodic payments, as allowed under rule 72(t) of the Internal Revenue Code. Accounts eligible for this treatment include 401(k), 403(b), 457(b), IRA, and Thrift Savings Plans. Anyone can initiate a SEPP; you do not need to be unemployed/retired. Importantly, your current retirement account is not eligible if you are still working.

Calculating a SEPP requires using the appropriate IRS life expectancy table and selecting from among three possible distribution methods (amortization, annuity, or minimum distribution). Frankly, it is probably not something you want to do on your own. Regular withdrawals must occur annually and last for at least 5 years or until you turn 59 ½.

If you start at age 40, you need to withdraw for 19 ½ years. If you start at age 58, you need to take withdrawals for 5 years. Not fulfilling the withdrawal obligations will subject all previous withdrawals to early withdrawal penalties. You are generally locked in once you establish your withdrawal method, but the IRS does allow a one-time change from either of the fixed methods to the minimum distribution method.

Roth IRAs

You can withdraw contributions you made to a Roth IRA anytime, tax and penalty-free. If you are under age 59 ½, you may owe taxes and penalties on any earnings you withdraw. The good news is that you can elect to withdraw your contributions first, i.e., you do not need to withdraw funds pro-rata. You may withdraw earnings without penalty under certain circumstances, though you will still owe taxes. These circumstances include, but are not limited to: a first-time home purchase, qualified education expenses, expenses related to a birth or an adoption, and unreimbursed medical expenses.

Summary

There are ways to access retirement funds before age 59 ½ without penalty. Each method has its own rules and consequences for breaking them, so it is best to solicit advice from a financial advisor and consult with your tax professional/accountant to help determine which method is best for your personal situation. Spending a little extra time and effort upfront can avoid costly headaches down the road.

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