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Did you know that 60% of retirement savers feel overwhelmed by their 401(k) plan information and question their ability to manage their accounts successfully? Even more surprising, one in three people don’t even know how to access their 401(k)—potentially leaving valuable, tax-advantaged dollars on the table. That’s a problem, especially as your 401(k) or 403(b) could become one of your largest assets in retirement.
If you’re thinking about early retirement, chances are you’ll need to take early withdrawals from your retirement account. Retiring early means you won’t have access to Social Security benefits, which means you’ll need to not only pay for your living expenses but also added expenses like health insurance. Using the Rule of 55 to take early withdrawals can help cover those costs.
What is the Rule of 55?
Under the Rule of 55, you can withdraw funds from your current job’s 401(k) or 403(b) plan without incurring the standard 10% early withdrawal tax penalty. This provision applies if you leave that job in or after the calendar year you turn 55. It’s a provision designed for those who separate from service early but need access to their funds before the typical retirement age of 59 ½. Qualified public safety workers can start taking withdrawals even earlier, at age 50. This rule applies whether you were laid off, fired, or simply quit your job.
While this rule can provide a lifeline for early retirees, it’s crucial to remember that distributions are not completely tax-free. Like all withdrawals from a traditional 401(k) or 403(b), you still have to pay income tax.
To start making withdrawals, you’ll have to prove to the plan administrator that you qualify by complying with a few rules:
- Age of retirement: You must leave your job during or after the calendar year you turn 55.
- Work: You must leave your job to start taking withdrawals, but you can return to work later and continue to take penalty-free distributions.
- Retirement account: You can only withdraw funds from your most recent 401(k) or 403(b) account under the Rule of 55. The government does not permit penalty-free withdrawals before 59 ½ from plans you had with a previous employer.
Example of the Rule of 55 in Practice
Let’s consider a public safety employee, such as a firefighter, who has a 401(k) through their state government employer. This employee decides to retire from their position at age 52, having met the criteria for a qualified public safety worker. Because they are a public safety employee, the Rule of 55 is available to them starting at age 50. After separating from service, they can begin taking penalty-free distributions from that 401(k) plan. However, this exception only applies to the funds in the plan they had with that specific employer. If they have a separate 401(k) from a previous, non-public safety job, they would not be able to access those funds under this rule without incurring a penalty.
The Catch: Why the Rule of 55 Isn’t a Simple Solution
Beyond simply meeting the criteria, it’s important that you effectively plan the timing of those withdrawals due to tax considerations. If you were employed for most of the year and had a relatively high income, it may make sense to not withdraw money under the Rule of 55 in that calendar year, since it will add to your total income for the year and possibly result in you moving to a higher marginal tax bracket.
Without a holistic view of your financial picture, you might unknowingly make one or more of these common mistakes:
- Risk Management: If you don’t get the risk right in your 401(k)s, you may not stick with the portfolio and financial plan. Without considering all accounts, you could end up with a concentrated risk position in one asset class, like “doubling up” on U.S. large-cap equities. This lack of a “big-picture” view can lead to wrong behavior when markets become volatile.
- Tax Inefficiency: Withdrawing a large lump sum could push you into a higher income tax bracket, defeating the purpose of a penalty-free withdrawal. Without proper tax location, you might have tax-inefficient funds in your taxable accounts and vice versa, which can increase the total “fees” you pay to the government.
- Lack of Diversification: Holding assets in multiple accounts at different institutions can make achieving true diversification difficult. Managing these accounts in isolation can lead to an inefficient portfolio that is not aligned with your long-term goals.
These are the kinds of financial complexities that add unnecessary stress to your life.
The Intelligent Investing Solution: Integrating Your Held-Away Assets
At Intelligent Investing, we believe managing your retirement savings should be simple—not stressful. That’s why we created Intelligrations®, our proprietary technology that allows us to intelligently integrate and manage your 401(k) or 403(b) while you’re still working. We developed this proprietary financial software in-house to help organize our clients’ “financial junk drawers.”
Using our Intelligrations®, we are able to organize your financial life. This innovative technology allows us to proactively monitor, manage, and trade your held-away assets, such as 401(k) accounts, just like your other assets with us. An annual static review is simply not enough.
With Intelligrations®, we help you:
- Select the Right Investments: We tailor your investment choices to support your long-term retirement goals.
- Monitor and Rebalance Your Plan: We proactively oversee your 401(k) or 403(b) and adjust your allocations as needed.
- Align with Your Risk Tolerance: You receive a personalized risk number that encompasses your entire portfolio in real time, including the assets we are directly managing and the held-away assets we will manage for you. This helps align your risk to provide a smoother financial journey.
- Minimize Taxes: Intelligrations® helps us with tax location, ensuring investments are properly allocated to the appropriate accounts.
You’re Not Alone
You don’t have to navigate complex financial decisions like the Rule of 55 alone. If you’ve ever felt unsure about your 401(k), you’re not alone—and we’re here to help. Our mission is to minimize your financial stress so you can maximize your life.
To learn more about how to get your retirement savings on track, download our complimentary e-book entitled, “Is Your Portfolio on Track?”
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