How to avoid early withdrawal penalties on your 401k

Lunch room hearsay will lead you to believe that you can’t touch your 401(k) assets without incurring an early withdrawal penalty until you are age 59 ½. This is true in most cases—however there is an important exception to the rule.

When Can I Access My 401(k) Without An Early Withdrawal Penalty?

The relationship you have with your employer may end for a number of reasons, such as retirement, corporate downsizing, or moving out of state. The good news is that you may have more asset liquidity than you realized. If you separate from your company between the ages of 55-59 ½, you may withdraw assets from the 401(k) without penalty. This provision is commonly referred to as the Rule of 55.

However, there are a few important items to be aware of:

  • The provision may only be utilized after separation from the current employer.
  • Only assets in your current plan are applicable for the penalty free withdrawal. If you have old 401(k) accounts from previous employers, you’ll have to wait until age 59 ½ to withdraw those funds. It may be beneficial to consolidate your old 401(k) plans into your current plan prior to separating from the company, thereby boosting the amount of assets you can potentially access without penalty.
  • 401(k) accounts and IRA accounts operate under different rules. The Rule of 55 does not apply to IRA accounts, which require you to wait until age 59 ½ to withdrawal assets penalty free.
  • Withdrawals will still be taxed as ordinary income.

Bottom Line

It is very common for people to rollover 401(k) assets into an IRA upon retirement or separation from a company. In many cases, doing so makes a lot of sense. However, if you are between the ages of 55-59 ½ beware! You should think twice as it may be in your best interest to keep your assets in the employer sponsored 401(k) plan.