As we all know, in general you can’t withdraw from retirement accounts before you are 59-1/2, otherwise you’d have to pay a 10% penalty. If you retire early and you want to use the money in retirement accounts before you are 59-1/2, there are some exceptions such as withdrawing contributions and conversions (after 5 years) from a Roth account, and setting up 72(t) substantially equal periodic payments.
There’s also a special rule that only applies 401k-type plans, not IRAs. If you retire when you are 55 or over, you can withdraw from the 401k plan and not owe the 10% penalty. As we go into the details, we see this special rule isn’t that useful after all.
Must Retire At 55 Or Later
In order to take advantage of the special rule, you must terminate your employment with the company during or after the year you are 55. You can’t retire earlier and just wait until you are 55.
Only From That Company’s Plan
Say you retire at 55 or later. Only withdrawals from that company’s plan are penalty-free. If you have money with your previous employers’ plans, and you left those employers before the year you reached 55, you still have to pay the 10% penalty if you withdraw from those plans. If you did a rollover to an IRA, withdrawing from the IRA before 59-1/2 is still subject to the 10% penalty.
A workaround could be to consolidate your retirement account money into your employer’s plan, terminate after 55, and then take withdrawals from that plan. That assumes this employer’s plan accepts rollovers from other plans, and possibly from IRAs.
Only If The Plan Allows Partial Withdrawals
Even if you meet the previous two conditions, you can still be thwarted if the plan doesn’t allow partial withdrawals. Many plans only want to do full withdrawals. You can ask for a cash out or you can ask for a rollover, but it has to be 100% of the account balance. In that case, if you ask for a cash out, you won’t owe the 10% penalty but the full balance will be taxable at once. If you do a rollover, as soon as the money gets into the IRA, you lose the special exemption on the 10% penalty.
Because of these limits, the special rule on age 55 penalty-free withdrawals from 401k-type plans actually isn’t that useful. Things must line up really well for you to take advantage of it, and it’s only applicable for a handful of years — when you are between 55 and 59-1/2.
Because you need to cover many years after you are 59-1/2, I believe if you must touch your retirement account money before you are 59-1/2, you really don’t have enough saved. You can forget about all the clever maneuvers to access your money before 59-1/2. Even if you can, you don’t want to, because that money is reserved for years after.
Not worrying about how to take your money out sooner also makes your life much easier.
Reference: Exceptions to Tax on Early Distributions, IRS.