Understanding the Rule of 55

Understanding the Rule of 55

Employers should be aware of the IRS Rule of 55, which allows employees who separate from service in the year they turn 55 or older to withdraw from their current 401(k) or 403(b) plan without the 10% early withdrawal penalty

• This rule only applies to the plan associated with the employer from which the employee is retiring.

• It does not apply to IRAs or plans from previous employers.

• Employers must ensure their plan documents support this provision, as it's not optional under IRS rules

1. Plan Administration and Compliance

Employers need to:

• Verify age and separation timing to confirm eligibility for penalty-free withdrawals.

• Educate HR and benefits teams to handle early retirement requests properly.

• Ensure plan administrators are prepared to process withdrawals under the Rule of 55 and withhold appropriate taxes

2. Communication and Employee Guidance

Employers should provide clear guidance on:

• Withdrawal options and tax implications.

• The importance of not rolling over the 401(k) to an IRA if the employee wants to use the Rule of 55

• Alternatives like SEPP (Substantially Equal Periodic Payments) for those under 55

3. Impact on Workforce Planning

Early retirements can affect:

• Succession planning and talent retention.

• Workforce costs, especially if retirees are replaced or if benefits like COBRA are extended.

• Pension obligations or other long-term liabilities, depending on the employer’s retirement structure.

4. Legal and Fiduciary Responsibilities

Employers should:

• Ensure plan compliance with IRS rules.

• Avoid giving personal financial advice—instead, refer employees to financial advisors.

• Maintain documentation of retirement decisions and plan provisions.

Please review the complete rule of 55 on the IRS website.

Retirement topics - Significant ages for retirement plan participants | Internal Revenue Service