Retiring Early? Here’s How You May Be Able to Tap Your 401(k) Without a Penalty

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You’ll generally face penalties for tapping a 401(k) prior to age 59 1/2. Read on to see how there can be an exception to this rule. 

There’s a benefit to saving and investing for retirement in a 401(k) or IRA, as opposed to a regular brokerage account. With a traditional 401(k) or IRA, your contributions go in on a pre-tax basis. This allows you to shield some of your income from the IRS.

Plus, with a regular brokerage account, when you sell investments at a profit, you’re required to pay capital gains taxes for that tax year. With an IRA or 401(k) plan, gains are tax-deferred until you take withdrawals.

But there’s a drawback of saving in an IRA or 401(k). These plans come with rules that dictate when you’re allowed to access your money.

If you tap an IRA or 401(k) prior to age 59 1/2, you’ll generally be assessed a 10% early withdrawal penalty. There are a few exceptions, such as being allowed to tap an IRA early to buy a first-time home. Otherwise, you risk losing a large chunk of your savings by accessing that money early.

But what if you end up in a position where you want to retire sooner than 59 1/2? Or what if you’re forced to stop working sooner than that because your company folds and you can’t find another job?

The good news is that in some cases, you can tap your 401(k) early without facing a penalty. But you’ll need to know how the rules work in that situation.

You may be able to get your retirement money at age 55

If you have a 401(k), you may be able to take withdrawals from it without penalty if you turn 55 during the calendar year you lose or leave your job. And to be clear, it doesn’t matter whether your departure is voluntary or not. However, there are some rules to follow.

First, you can only take penalty-free withdrawals from the 401(k) plan the employer you separated from was sponsoring.

In other words, let’s say you work for the Smith Corporation and have $40,000 in that 401(k). You might also have a $25,000 balance in a 401(k) sponsored by the Jones Corporation, a company you formerly worked for.

If you’re leaving the Smith Corporation at age 55, you can tap the 401(k) the Smith Corporation was sponsoring without penalty. But you can’t start withdrawing from your balance in your Jones Corporation 401(k).

Similarly, you can’t decide to roll the balance of your Smith Corporation 401(k) into an IRA. That’s a common thing for people to do once they separate from an employer. But in that case, you’ll have to wait until 59 1/2 to take withdrawals penalty-free.

Also, you must actually leave your job at age 55 or later to be able to take advantage of penalty-free 401(k) withdrawals. Let’s say you leave the Smith Corporation at age 54. You can’t just wait until age 55 and then start taking withdrawals from its 401(k). In that case, you’ll be penalized.

However, 55 is the minimum age where this leeway applies. So if you leave the Smith Corporation at age 56, you can take penalty-free withdrawals from its 401(k) plan then.

A good 401(k) option to have

You never know when you might end up retiring early — whether by choice or due to circumstances outside of your control. So the fact that you can, in some cases, tap a 401(k) at age 55 without penalty is a good thing.

However, you may want to take steps to protect yourself from penalties in case this option doesn’t end up being available to you but you wind up retiring early. Consider housing a small portion of your retirement savings in a regular brokerage account. You’ll give up the aforementioned tax breaks on that chunk of your savings, but you’ll have the flexibility to tap your portfolio penalty-free whenever you want.

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