Tapping a 401k – is it age 55 or 59 1/2? Strategy?

401k bottleMost people are aware of the 59 1/2 age rule to begin withdrawing money from an IRA without tax penalty. Few are aware that age 55 is when this applies to a 401k. What are your options?

Caveat (of course): you need to have left your employer – how doesn’t matter – at 55 or older as the key age. If you leave prior to 55, then that 401k gets the 59 1/2 rule applied.

Leave in January, and turn 55 in December, still qualifies any 401k withdrawals that year without the 10% IRS penalty. Note – the 59 1/2 rule is different – here you need to have reached 6 months after your 59th birthday.

Roll the 401k into an IRA – age 59 1/2 applies.

Of course, tapping into retirement funds early risks running out of money at older ages. So withdrawals at these younger ages, 55 or 59 1/2, should be only made out of temporary necessity for living expenses – hopefully, until employment elsewhere is found.

On the other hand, an IRA typically has more investment choices – the world is your oyster compared to most 401k plans. So how can you have both access to your money at age 55 and more investment choices from an IRA? If your 401k plan allows (partial transfers? and periodic withdrawals?), leave what you may need in the 401k and transfer what you won’t need into the IRA.

Example: You are 55 now. You estimate you may need an extra $10,000 a year temporarily while you look for new employment. You don’t know how long that might take. So leave $50,000 in the 401k (if it allows partial withdrawals – $10k / year) which would bridge you past 59 1/2, and transfer the rest to an IRA (if it allows partial transfers).

  1. If you find employment before the 5 years are up, then you can stop the partial withdrawals from the 401k (and consider transferring the balance to your IRA).
  2. If you don’t find employment over the 5 years, then you can start partial withdrawals from your IRA now that you’ve reached 59 1/2.
  3. If you’re older than 55, but younger than 59 1/2, when you leave your 401k employer, then multiply how much you need by the number of years until you reach 60 (easier number for math than 59 1/2).

If your 401k plan isn’t flexible – then you can transfer everything to your IRA and then evaluate the breakeven point for IRAs and the 59 1/2 rule. Even paying the penalty for a short period of time might be less expensive than paying taxes for the longer period of time under the 72t rules.

Photo by MIKI Yoshihito (Flickr: 401K – Perfect Solution !?) [CC BY 2.0], via Wikimedia Commons


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