Can I Withdraw From my 401(k) or IRA Before 59.5?
In most cases, the IRS will not allow you to withdraw retirement savings without an early withdrawal penalty before you turn 59.5. However, there are some exceptions like the rule of 55, option 72t, Roth ladders, among others which will allow you to use retirement savings earlier if you so desire.
There are many who have done a good job saving and investing over the years who find themselves in the enviable position of possibly taking early retirement.
However, most tax-advantaged retirement savings vehicles come with age restrictions designed to deter us from using those funds earlier in life.
Age 59.5 is the minimum age to tap retirement savings penalty-free for 401(k)s, 403(b)s, and IRAs, but there are exceptions that you may be able to take advantage of.
In this post, we’ll cover the most popular types of retirement accounts and any opportunities that exist to tap these for a source of income earlier than traditionally expected.
401(k)s
About 50 years ago some employers enacted policies to give their employees cash directly in lieu of making an employer contribution to a tax-qualified retirement account.
Congress didn’t think too highly of the practice and outlawed it in 1974.
In 1978, congress added section 401(k) to the internal revenue code to reauthorize employer contributions, but with a new legal framework designed to encourage retirement saving for workers’ later years.
For a few years, 401(k)s were barely used until Congress further enhanced the code in 1981 allowing funding through payroll deductions.
Within two years, nearly half of all large U.S. corporations had plans in place or in the works.
Here we are in 2023, and the 401(k) reigns supreme as the high monarch of the retirement account kingdom.
According to the census bureau, 401(k)s and thrift savings plans are almost twice as likely to be the retirement account of choice over IRAs or defined benefit pension plans.
There are many features and limitations of 401(k) plans.
As it relates to early retirement, withdrawals made before the account holder turns 59.5 are subject to an early withdrawal penalty of 10% in addition to any applicable income taxes.
Clearly, this deterrent exists to encourage people to preserve their retirement savings for retirement as opposed to using the money for a pool or camper.
But what if you’re ready to retire at age 55? Or even 50?
While not completely without difficulty, there are options one can consider in order to access 401(k) funds prior to 59.5 without paying the 10% early withdrawal penalty.
Roth 401(k) Contributions
If you’ve been contributing to a Roth 401(k) for some time, you may have enough contributions to fund or at least act as a bridge for early retirement.
Roth contributions (not earnings) are always able to be withdrawn without any tax obligation or early withdrawal penalty. This is because Roth contributions have already been taxed.
Be sure the 401(k) custodian is keeping up with how much is contributed and when so you are able to distinguish between contributions and earnings if you decide to make an early withdrawal.
Once these funds are commingled, it can be difficult to separate them without good records.
If at all possible, I would try to avoid tapping any Roth assets as their ability to grow tax-free makes them especially valuable.
The rule of 55
If you leave your employer for any reason at age 55 or later, you may be able to begin making penalty-free 401(k) withdrawals when you break service.
This is known as the rule of 55.
Basically, this provision allows you to end service with an employer, whether it’s by your choice or not, and begin 401(k) withdrawals, penalty-free.
You must be at least 55 and use the plan from the company from which you ended your employment. You cannot use a plan from a previous employer or roll funds from the plan into another 401(k) or retirement account.
You also cannot end employment at any age before 55 and begin withdrawals when you turn 55. You must be at least 55 when your employment ends, though you can wait until the following year to begin early withdrawals.
Not all 401(k) plans offer this option, so be sure to check before you count on this strategy.
Rule 72(t) or Substantially Equal Periodic Payments (SEPP)
Rule 72(t) is an IRS provision that allows owners of 401(k), 403(b), and IRA plans to withdraw funds from these accounts penalty-free, at any age.
To use 72(t), account owners must withdraw no less than 5 annual substantially equal periodic payments (SEPP) or take them until age 59.5, whichever occurs later.
There are three formulas the IRS provides that can be used for calculating how much your SEPP should be. They are known as the amortization method, the minimum distribution method, and the annuity factor method.
The amortization method basically determines an annual withdrawal amount by amortizing the owner’s account balance over the course of their single or joint (if married) life expectancy.
It utilizes life expectancy tables and federal mid-term interest rates, so you’ll need to visit the IRS website to figure out your number.
This formula will produce the largest payout of the three and it is fixed annually so it won’t ever change.
The minimum distribution method also utilizes life expectancy tables but uses a factor to divide into the retirement account balance.
This makes the payout the smallest of the three methods and it also means the amount will vary from year to year.
Finally, using the annuity factor method account holders divide their retirement account balance by an annuity factor.
The annuity factor is calculated based on the mortality table in Appendix B of IRS rule 2002-62 and reasonable interest rates up to 120% of mid-term federal rates when the calculation is made.
This also results in a changing number and the amount will land somewhere between the previous two methods.
You probably noticed, but these calculations are quite complex. Mess them up and you could trigger severe tax or early withdrawal penalties, if not both.
We strongly recommend reaching out to a tax professional if you want to exercise rule 72(t).
Roll over to or from an IRA
If your 401(k) plan allows for in-service distributions or it accepts rollovers from outside IRAs, you could consider rolling funds around in order to utilize one of the aforementioned options.
If rolling into the 401(k) from an IRA to use the rule of 55, be sure you roll the funds over before you leave your company. You won’t be allowed to roll them over and use them for early withdrawals after you terminate employment.
Thrift Savings Plan
For those of you who work for the government and wonder when we’re going to talk about the TSP, your moment has arrived.
Basically, all the rules that apply to 401(k)s also apply to the TSP, so see the previous section for your options.
There is one notable exception.
If you are in the military you could look into a Qualified Reservist Distribution (QRD). To qualify you must be a reservist called to duty for an overseas deployment that lasted at least 179 days or an indefinite period.
The QRD exception is designed to assist reservists with the sudden financial burdens of being deployed for an extended period.
If you happen to qualify for this, it doesn’t seem likely that you’d also be in a position to use the money for funding an early retirement.
The QRD exception also applies to 401(k)s, 403(b)s, and IRAs.
IRAs
Second in the United States to 401(k)s in terms of total invested assets, the Individual Retirement Account or IRA is a stalwart of retirement savings. Many Americans have both a 401(k) and an IRA.
Like 401(k)s, the IRS penalizes early withdrawals from IRAs made before age 59.5 and, also like 401(k)s, there are a few ways to navigate around this provision if you so choose.
First, the rule of 55 does not apply to IRAs, but option 72(t) is available if you want to go that route.
Next, you can utilize any Roth contributions. As we mentioned above, Roth contributions have already been taxed so they can be withdrawn tax and penalty-free at any time.
Contributions cannot be replaced once removed, however, so don’t forget that you’re lessening the growth potential of the account by removing your contributions. Of course, if the account is large enough and you’re ready to retire, you may not care.
Roth Conversion Ladder
A unique strategy for tapping IRA funds for early retirement is the Roth Conversion Ladder.
As you may already know, if you convert traditional IRA funds into a Roth IRA you will be forced to pay income tax on the amount rolled over.
What you may not know is that the entire amount converted is then treated similarly to a contribution by the IRS.
Normally, individuals are only allowed to make contributions of $6,000 or $7,000 depending on their age. However, there is no limit on how much you can convert in a given year.
As a result, if you convert large amounts from a traditional IRA into a Roth IRA, these funds are eventually available for penalty-free withdrawals like contributions.
The catch is you must have the converted amount in the account for at least 5 years before making a withdrawal, even after you reach 59.5. This is where the ladder comes in.
By thinking 5 years ahead, you can potentially convert an amount that you’ll want to withdraw 5 years further down the road.
Just repeat the process each year until you’ve successfully funded your retirement bridge and can use other retirement funds penalty-free by turning 59.5 or using another strategy we’ve discussed in this post.
For example, suppose you are 45 and have $350,000 in a traditional IRA.
Overall, your retirement saving and investing have gone well and you have more than enough to retire at 59.5, but want to move that date up if possible.
You’ve calculated that you need about $50,000 a year in addition to other savings to act as a monetary bridge until you can tap other retirement accounts.
Assuming your IRA balance doesn’t change (unrealistic I know, but just bear with me for the sake of simplicity), you could begin converting $50,000 per year for seven years to a Roth IRA beginning at age 48.
This will allow you to retire and begin annual early withdrawals at age 53, and continue to use the Roth for income until you reach 59.5.
Here’s what this exercise would look like in chart form:
Year | Age | Conversion Amount | Withdrawal Amount | Original Conversion Year |
2022 | 45 | $0 | $0 | |
2023 | 46 | $0 | $0 | |
2024 | 47 | $0 | $0 | |
2025 | 48 | $50,000 | $0 | |
2026 | 49 | $50,000 | $0 | |
2027 | 50 | $50,000 | $0 | |
2028 | 51 | $50,000 | $0 | |
2029 | 52 | $50,000 | $0 | |
2030 | 53 | $50,000 | $50,000 | 2025 |
2031 | 54 | $50,000 | $50,000 | 2026 |
2032 | 55 | $0 | $50,000 | 2027 |
2033 | 56 | $0 | $50,000 | 2028 |
2034 | 57 | $0 | $50,000 | 2029 |
2035 | 58 | $0 | $50,000 | 2030 |
2036 | 59 | $0 | $50,000 | 2031 |
The Roth ladder is a relatively simple strategy to carry out, it just requires some planning in advance.
As you investigate this strategy, be sure to keep an eye on your tax brackets.
Conversions go on top of income and can easily push you into higher brackets. The higher the tax bracket you’re forced to convert at, the less attractive this option becomes.
403(b)s
403(b)s are typically offered to public school employees and, when it comes to early withdrawals, are treated by the IRS much like a 401(k).
In fact, nearly all the rules for 403(b)s are identical to 401(k)s.
You must be 59.5 to make penalty-free withdrawals from a 403(b), but the rule of 55 also applies.
Again, to use the rule of 55, you must retire from the employment that also established the 403(b) when you are 55 or older, and you can only access funds from that plan.
Like a 401(k), you can roll 403(b) assets into an IRA or Roth IRA, which would allow you to potentially use the 72(t) option we mentioned above or the Roth Conversion ladder if you roll the funds over early enough.
403(b)s also have a unique catch-up provision that you might want to investigate if you are able to put more into the account as you approach retirement.
It’s called the “15-year rule” and allows account holders to contribute an additional $3,000 per year up to a lifetime max of $15,000.
457s
457 plans are from a different section of the internal revenue code and have some notable differences when compared to 403(b) or 401(k) accounts.
For the purposes of this post, the key feature you need to understand about 457s is that there is no age requirement for withdrawals; only that you retire from employment at the organization that owns the plan.
You see, 457s are for non-profit employees, many of which work in emergency services like police or firefighting.
Because these jobs can take a particularly high physical toll, retirees are allowed to access these accounts earlier than other retirement options.
While this flexibility is certainly a plus, one downside of 457s is they are very restrictive on hardship withdrawals. The 457 basically has to be the last resort for you to access the funds for a hardship.
Taxable accounts
Milestone 6 on the Next Dollar Roadmap is saving for flexibility in bridge accounts. This is where we first introduce the idea of saving for the future in a taxable brokerage or savings vehicle.
The reason is the flexibility these funds provide.
The basis of this post is built on the restrictions the IRS has put in place over nearly all the tax-advantaged retirement savings options available.
If you want to retire before 59.5, you’re going to have to jump through hoops OR you’re going to need money available elsewhere.
Enter the taxable brokerage account.
These accounts provide access to all or more of the same investments you may use in other tax-advantaged spaces, but with complete flexibility to make withdrawals at any time, penalty-free.
Of course, you will have to invest after-tax dollars and any gains will be taxed too.
However, if your gains are from the purchase of an asset that was bought over one year prior, then they’ll be taxed at a more favorable long-term capital gains rate.
Long-term capital gains rates fall into three brackets but are all much lower than short-term capital gains which are all taxed at normal income tax rates.
The point is, even though you don’t get the same level of tax-advantaged savings using taxable brokerage accounts, there’s still quite a bit of tax savings by investing here AND you get total flexibility to sell investments as needed.
This flexibility will be incredibly helpful as you approach retirement and even after because it will allow you to pull income from one of three locations:
- Pre-tax savings (like traditional 401(k)s and IRAs;
- After-tax savings (like Roth 401(k)s and IRAs), and;
- Taxable savings (the taxable brokerage account)
Having sufficient funds in all three of these spaces gives one maximum control over which sources they use for income, thus providing maximum taxation optimization.
Is taxable income pushing you close to another bracket? No problem. Just pull the Roth lever for tax-free cash.
Is there plenty of room left in your bracket for Roth conversions? Great. Just convert those pre-tax funds to the Roth and use your taxable brokerage bucks to pay the tax.
Want to retire early, but can’t get to your 401(k) or IRA without a pesky penalty? Good thing you have the taxable brokerage to pull income from. Now you can leave work and fund retirement until you reach 59.5.
Final Thoughts
First, the earlier you can plan for this, the better.
This is why we encourage you to regularly calculate your net worth.
As you save over the years, a sort of snowball effect will begin to occur in your investments and you may find yourself able to retire much sooner than you previously thought possible.
If you’re not keeping an eye on that, you may not have time to arrange accounts in order to retire as early as possible (if that’s something you want to do).
Even if you don’t want to retire early, why not leave the possibility open by arranging things accordingly?
Who knows, you may change your mind or your employer may change it for you. ☹
Next, keep in mind that withdrawals will erode any account’s ability to grow. The earlier you tap those Roth contributions, the heavier the impact will be on the long-term potential of the account.
Roth savings are the most valuable dollars you’ll have for optimizing taxes in retirement and for legacy planning. You’ll never feel like you have too much of them.
Finally, in nearly every case, the IRS does make exceptions in retirement accounts for hardships like disability or a medical emergency.
If this applies to you, you should look into it. We didn’t cover those exceptions here because the post is primarily about options for retirees.
