Most people are unaware of the available strategies on how to withdraw from a 401(k), 457(b), 403(b), TSP, IRA and not pay the penalty if you want to retire before age 59 1/2.
If you’re looking to retire early and you’ve put enough money away in your 401(k), one of the most important questions to answer is:
How am I going to pay for my early bird dinners at 4:30 in the afternoon?
You can’t collect social security until age 62 (for now). The imperial federal government wants to protect you from going broke by hitting you with a penalty if you take money out of retirement accounts before age 59 1/2.
But smart people like you aren’t relying on the government to take care of them. And neither should you rely on the government to do your retirement or early retirement planning.
There are ways to take early withdrawals from your 401(k) without paying the 10% penalty before age 59 1/2. I’ll share with you how to do it.
Failure to consult with a professional (CPA, CFP) who has experience in executing these strategies may leave you 1) broke or 2) paying huge (potentially retroactive) penalties.These strategies are 100% legal and allowed by the IRS. But they must be executed perfectly, or the big, bad tax man will eat your lunch. You have been warned.
How To Get Started Investing
The international bestseller by CERTIFIED FINANCIAL PLANNER™ Scott Alan Turner. Choose the right accounts & investments so your money grows for you – automatically. No jargon, confusion, or pie in the sky promises. Just a proven plan that works.

A note on taxes
When you take a distribution from your tax-deferred retirement accounts, you will pay ordinary income taxes on the distribution.
If you take a 401(k) distribution at age 50 and you’re in the 25% tax bracket, you’ll pay ordinary income taxes at your marginal tax rate.
If you take a distribution at age 65 and you’re in the 25% tax bracket, you’ll pay ordinary income taxes at your marginal tax rate.
This article isn’t about minimizing your ordinary income taxes. But realize the only difference between an early retirement withdrawal at age 50 and age 65 is the potential to pay an additional 10% tax. The 10% tax is what you’re trying to get around if you want to take an early distribution.
In IRS lingo, they don’t call it a penalty, even though that’s what it is. Sometimes it’s called the 10% penalty, which it is. They don’t want you to touch that money until age 59 1/2. If you look at the IRS Forms (Form 5329 or Instructions for Form 5329) an early distribution is subject to an additional 10% tax.
There are a couple of ways to take early withdrawals. Make sure to read about both options because they are very different.
How to withdraw from a 401(k) at age 55
Under the right circumstances, you can withdraw from a 401(k) at age 55 (not 59 1/2) . If you retire, quit or get fired between age 55 and 59, you can withdraw without penalty from your 401(k). See IRS Publication 575
The tax doesn’t apply to distributions that are: From a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees)
What is separation from service? Here’s how the IRS defines it:
Separation from service. To meet the requirements for the first exception in the list above, you must have separated from service in or after the year in which you reach age 55 (or age 50 for qualified public safety employees). You can’t separate from service before that year, wait until you are age 55 (or age 50 for qualified public safety employees), and take a distribution.
If you leave your job before age 55 – you can’t take a distribution without paying the 10% penalty. If you wait until after you turn 55 (after your 55th birthday) you can take a distribution without paying the 10% penalty.
See page 34 of the publication.
There are several important points to know about the “Rule of 55.”
The Rule of 55 for early withdrawals from 401(k)s
Here are a few things to keep in mind when considering retiring between age 55 and 59 1/2 and using the Rule of 55 to take early distributions:
- Timing is everything You must be 55 and then leave your job (age 50 for public safety employees). If you quit before your 55th birthday, you can’t use the Rule of 55 and have to wait until age 59 1/2.
- The exception only applies to the 401(k) at your current employer If you have another 401(k) from an old employer, you can’t take an early distribution from the old 401(k). The Rule of 55 only allows you to avoid the 10% tax on distributions from the 401(k) at your current employer. However: You can get around this by rolling old 401(k)s into your current 401(k) before you leave your job. Boom! Gotta love loopholes.
- This strategy doesn’t apply to IRAs If you roll a 401(k) into a traditional IRA, you lose the ability to take an early withdrawal and use this exception. You might want to get into better investment choices by doing a rollover, but the simplicity of pulling out money penalty free between age 55 and 59 1/2 goes away.
If all that looks good to you, that’s the simpler and less risky of the two methods to get your money sooner.
The pros of using the Rule of 55
- Access to your money before age 59 1/2 penalty free.
- No limits on how much you can withdraw
The cons of using the Rule of 55
- Doesn’t work well for really early retirement. Well, first you have to wait until age 55 to quit your job. If you dream of retiring before age 55, you can pretty much forget this strategy.
- Takes a lot of planning not to go broke Either strategy has this potential pitfall. If you retire at 45 and live for another 50 years (until age 95), you better have a rock solid plan not to go broke.
Withdraw money penalty free from your 401k, 403(b), TSP, 457 plan or IRA early using IRS rule 72(t)
Next, we have another wonderful section of the IRS code that is referred to as a 72(t) distribution, or Substantially Equal Periodic Payments.
It’s an exception to the 10% early withdrawal penalty so you can take money out of your 401(k) (or qualified retirement plan) or IRA before age 59 1/2. Unlike the Rule of 55, rule 72(t) doesn’t care how old you are or when you leave your employer.
How 72(t) works step-by-step
No lie, it’s a tad on the confusing side. We’ll use an example first:
- Joe is age 50 and quits working
- He rolls his 401(k) into a traditional IRA (so he has better investment options, not because he needs to for the 72(t))
- Joe picks from one of the three IRS options available to get the SEPP amount he will withdraw each year penalty free. There are calculators to determine what the different amounts are for your specific situation.
- Joe applies to use 72(t) on his tax forms and pulls the exact amount from his tax-deferred retirement account penalty-free.
- Joe continues to withdraw the amount from his retirement account until age 59 1/2 or at least for five years, whichever is longer.
The amount of the SEPP is based on:
- your age
- the age of your beneficiary
- account balance
- the expected rate of return
- how long you expect to live, based on the IRS mortality tables. Note there are three ways to determine life expectancy. I’ve included one here for reference.
- which IRS-approved method is used to calculate the SEPP
Calculating Substantially Equal Periodic Payments (SEPP)
The IRS has three approved methods for calculating SEPP. It’s beyond the scope of this article to explain each method. Each method results in a different distribution amount. They are the:
- Required minimum distribution method
- Fixed amortization method
- Fixed annualization method
Each of these methods is defined by the IRS
Important things to know about SEPP
Like with the Rule of 55, if you don’t plan properly and start pulling money out of your retirement plan early you could go broke.
Taking substantially equal periodic payments comes with another big warning:
Once you begin taking distributions, you MUST continue taking distributions until age 59 1/2 OR five years, whichever is longer.
For example, if you start taking payments at age 50, you must take them until age 59 1/2 (nine 1/2 years).
If you start taking payments at age 57, you have to take them until age 62 (five years).
If you start taking distributions and modify or stop taking payments, you’ll get hit with a retroactive 10% penalty for every year from when you started taking distributions.
Example: Joe is age 50. He decides to start taking SEPP from his 401(k) of $20,000/year. At age 53 the markets begin a three-year decline At age 56 Joe decides he can’t stomach the losses anymore and he needs to stop taking distributions and go back to work or else he’s going to run out of money later on. Joe will pay a 10% penalty on $20,000 – $2,000 – for every one of the six years he took distributions: $2,000 X 6 years = $12,000 tax penalty.
So you see, once you start taking distributions, it’s a very bad idea to stop. Which is why you need to do your homework and work with a professional who’s done 72(t) work for clients to get the plan right.
Note: The five-year rule is waived upon death or disability.
What happens after the period is over?
After you have reached the later of age 59 1/2 or at least five years of SEPP, you’re no longer required to withdraw money from the account. You can withdraw as much or as little as you want.
Calculating distributions using the 72(t) early distribution
There are many 72(t) early distribution calculators online. You can plug in numbers and see which of the three distribution methods gives you the highest or lowest possible distribution.
Applying to take 72(t) distributions
Don’t try this at home kids. Pay the few hundred bucks to consult with a tax pro or financial advisor. Yes, there are a few rare birds who have put in the hours to figure this stuff out on their own. They are the exception and not the rule.
Just because someone tells you something is easy doesn’t mean you should do it yourself. Do you want to trust your retirement to some stranger on an Internet forum or by reading a dozen blog posts (like this one!) on using a 72(t) to fund your early retirement? You have too much money at risk.
Ok, if you’ve calculated the periodic payment to take, what next? Take it! I’ll explain what generally happens, minus some details. When you do speak with someone, you’ll have some basic knowledge on the process.
- Liquidate the investments in your account.
- Request the money from the custodian or brokerage that manages your account
- Come tax time, you’ll get a 1099-R form, and the custodian/brokerage will send a copy to the IRS on your behalf (how kind!)
- Form 1099-R, box 7 will have a code in it. A code of ‘1’ means you’re taking a distribution before age 59 1/2 and are subject to an extra 10% tax. No worries – it just means the custodian doesn’t have a clue you’re doing SEPP or working under rule 72(t). If box 7 has a code of ‘2′ it means they did know about your SEPP/72(t) and you’re all good. But a code of ‘1′ means you’ll have to fill out IRS Form 5329 and let Ol’ Uncle Sam know he can stick it – you’re keeping your money.
For example here’s Form 5329. See Part I, line 2. Early distributions included on line 1 that are not subject to the additional tax (see instructions).
What do the instructions say?
Page 3 + 4 of the instructions:
Line 2
And from page 4, the exception for SEPP:
See? 100% legal and legit.
There you have it! Retire early and forget that pesky 10 % early withdrawal penalty!
How To Get Started Investing
The international bestseller by CERTIFIED FINANCIAL PLANNER™ Scott Alan Turner. Choose the right accounts & investments so your money grows for you – automatically. No jargon, confusion, or pie in the sky promises. Just a proven plan that works.
