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Early Retirement Distribution Options


Most people who have retirement accounts realize the importance of leaving these assets untouched until retirement age. Even if they don't, the government enforces a number of rules and penalties to discourage withdrawals before age 59½.

If you want to retire before age 59½ and begin taking distributions from your 401k plan, you will generally be subject to a 10% early distribution penalty. The early distribution penalty is the cornerstone of the government's campaign to discourage us from plundering our savings before our golden years.

Luckily, there are a couple of ways to do this without paying the 10% penalty.

Leaving Your Job On or After Age 55

The age 59½ distribution rule says any 401k participant may begin to withdraw money from his or her plan after reaching the age of 59½ without having to pay a 10 percent early withdrawal penalty.

There is an exception to that rule, however, which allows an employee who retires, quits or is fired at age 55 to withdraw without penalty from their 401k (the "rule of 55"). There are three key points early retirees need to know.

First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.

Second, if you still have money in the plan of a former employer and assuming you weren't at least age 55 when you left that employer, you'll have to wait until age 59½ to start taking withdrawals without penalty. Better yet, get any old 401k's rolled into your current 401k before you retire from your current job so that you will have access to these funds penalty free.

Third, this exception only applies to funds withdrawn from a 401k. IRAs operate until different rules, so if you retire and roll money into an IRA from your 401k before age 59½, you will lose this exception on those dollars.

Substantially Equal Periodic Payments

The substantially equal periodic payment exception is available to anyone with a 401k plan, regardless of age, which makes it an attractive escape hatch. It is called a Section 72(t) distribution. In a 72(t) withdrawal, the distributions must be "substantially equal" payments based upon your life expectancy. Once the distributions begin, they must continue for a period of five years or until you reach age 59½, whichever is longest. The full rules and life expectancy tables can be found in IRS Publication 590. This option generally gives you the least retirement pay out available.

Keep in mind that if you use too high a rate of withdrawal, you could run out of money, even before the 72(t) distribution ends, particularly if your investments decline in value substantially.

Final Comments

These two exceptions are only relevant if you are younger than 59½, since there is no penalty for withdrawals over this age.

Here is an additional resource on the General Distribution Rules related to 401k plans.

This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

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