What is the rule of 55 and how can I use it to reduce my taxes?

Ralph
00:00:00

Are you feeling trapped in your job? Are you dreaming of early retirement, but worried about touching your 401(k) before you turn 59 and a half? What if I told you there's a little-known rule that could be your ticket to financial freedom years earlier than you thought possible?

Today, we're diving into the rule of 55. That's a powerful strategy that could potentially save you thousands in taxes and penalties. Stay tuned to learn how this rule could be the key to unlocking your retirement dreams and reducing your tax burden sooner than you ever imagined.

Narrator
00:00:34

Welcome to the Ask Ralph podcast, where listening to an experienced financial professional with over 30 years of experience can help you make sense of confusing questions, current headlines and industry trends about taxes, small business, financial decision making, investment strategies, and even the art of proper budgeting. Ask Ralph makes complex simple by sharing his real world knowledge from a Christian perspective with all things financial.

Now here's your host, Ralph Estep Jr.

Ralph
00:01:04

Welcome to the show. Thank you for joining me. Let's start by taking a quick look back at yesterday's show. Yesterday, we talked all about purchasing special medical insurance for international travel. I told you about my mother's great fall. And it's a must listen to if you or somebody you know is planning to travel abroad anytime soon.

Before we jump into today's episode, I'd like to take a moment to share something personal with you. My mother-in-law, Dianne Bethard, she's currently battling the late stages of Alzheimer's disease. And in light of this, I've assembled a team representing the Ask Ralph show to participate in the upcoming Alzheimer's walk right here near me in Wilmington, Delaware. For those of you in the area, we'd be honored if you joined us this Saturday, October 19th.

Yup. That's in just two days. But there's still time for you to help. If you're unable to attend but still wish to support the cause, we've set up a donation page. You'll find the link in the show notes and listen, every contribution, no matter the size, brings us one step closer to defeating this devastating illness. And if you've known anybody that's going through it, it is truly devastating. And your support means the world to us and to the millions affected by Alzheimer's. And here's what I do know. Together, we can make a difference.

Well now, let's get to a message from one of our listeners. And this one comes from Tammy, and Tammy wrote me this note. She said, "Ralph, I'm 53 years old and I'm feeling burnt out in my current job. I've been contributing to my 401(k) for years, and I get those monthly statements, and I have built a great nest egg, but I always thought I couldn't touch that money until I was 59 and a half without facing steep penalties. Recently, I heard something about a 'Rule of 55' that might let me access my retirement funds early. Can you explain what this is and how it might help me retire sooner? I am desperate for a change but don't want to make a costly mistake."

Tammy, let me start by saying I hear your frustration and I'm glad you reached out. There are many people that find themselves in this similar circumstance to you. They feel like they're stuck because they don't know about tools like the rule of 55. So let's explore this rule of 55 and see how it might help you and others like you. Maybe this could truly be your escape route and a ticket to freedom.

Now, before we get into the details of the Rule of 55, let's turn to scripture for some wisdom on planning and stewardship. And I was thinking about your question. This verse relates perfectly to your situation, Tammy, and to our topic today. And it comes from the book of Ecclesiastes. This is chapter 3:1-2, and it says this. "There is a time for everything, and a season for every activity under the heavens: a time to be born and a time to die, a time to plant and a time to uproot."

This verse reminds us there are different seasons in our lives. Just like our careers, our finances, this Rule of 55 can be seen as a tool to help each of us transition from one season to another, especially from our working years into retirement.

So let's start by talking about what this rule is all about and how it might help you, Tammy and others in similar circumstances. Imagine this. Being able to retire early, access your hard-earned 401(k) funds, and avoid those dreaded early withdrawal penalties. Sounds too good to be true? Well, that's exactly what happened to my client, Barry, and it changed his life.

So let me tell you about Barry. Now Barry's this 54-year-old engineering executive. He'd been with his company for 20 years actually. Just like Tammy, he was feeling burnt out. He was longing for a change, and he had built up a substantial 401(k) balance. But he really thought he was stuck. He thought he had to wait until he's 59 and a half to access it without paying those penalties. And that's when I introduced him to the Rule of 55.

So let's start by talking about what is that. The Rule of 55 is an IRS provision that allows you to withdraw funds from your current job's 401(k) or 403(b) plan without that usual 10% early withdrawal penalty if you leave your job in or after the year you turn 55. Now I'm going to put a link to an article right from the IRS on this topic in the show notes so that you can get into it a little deeper if you want.

So check it out. Now this rule applies to workers who leave their job at any time during or after the calendar year they turn 55 or 50, if you're certain public safety employees. So when I shared this, as Barry learned about this rule, his eyes lit up. He realized for the first time he could potentially retire a year early without facing any steep penalties.

So we sat down, we carefully planned his exit strategy. We ensured he met all the requirements to take advantage of this rule. And here's how Barry implemented the Rule of 55 and how you can use it too. First thing you've got to do. You've got to verify your age. This is a hard and fast rule. You got to ensure you're leaving your job in the calendar year you turn 55 or later. It's very important. Second thing you've got to do. You've got to check your plan because not all 401(k) plans offer this option.

So Barry had to confirm with his plan administrator, to his employer, the HR people, that his employer's plan allowed for these 55 withdrawals. Now listen. You may need to go dig deep for this information from your employer. The person that answers the phone or addresses this in HR might not actually know the answer. She might have to dig deep. Third thing you got to do. And the third thing that Barry did was consolidate your accounts. Cause here's the deal. The rule only applies to the 401(k) from the job you're leaving at 55 or older. Now in Barry's case, he had an old 401(k) from a previous employer.

So what we did in his case, we worked with his broker, and we explored some options, and we were able to roll his current 401(k) together with that other ones. So now it was all in the same basket. Now, the next thing that Barry did, you got to plan your exit. Like we talked about. Plan that exit. Barry coordinated with his HR department to ensure his separation date fell within the correct timeframe. And listen, it's all about planning.

Like my grandfather always said, measure twice and cut once. The next thing you've got to do is you've got to budget carefully. Remember this. If you don't take away anything else I'm saying today, just because you can access the funds doesn't mean you should withdraw everything at once. And Barry's case, him and I created a detailed budget to ensure his withdrawals would sustain him through retirement and see, this is critical. You've got to manage your money to make it last. Just because you can take the money out doesn't mean it's a wise thing to do. And six. And the last thing I'm going to talk about here is to consider the tax implications. Now think about this. The rule of 55 waives that 10% penalty. That's that penalty if you take a distribution from a retirement plan before you turn 59 and a half, but here's the thing you've got to understand. The withdrawals are still subject to income tax.

So in Barry's case, we worked with him to plan his withdrawals in a tax efficient manner. Like I always say, if you listen to my show, you know I say this. Thoughtful tax planning is one of the keys to long-term financial success. It's just true. Those are facts. Now we talked about the Rule of 55.

We talked about how to implement it. Let's look at some of the pros and cons of using the Rule of 55. We'll start with the pros. First thing. Like Barry learned, and Tammy, you can use this to your benefit. It's a way to access your retirement funds early without penalty. We can call it the escape hatch or somebody else, I was doing some research, and they called it a 55 birthday present. Another pro to it. It gives you some flexibility to retire or change career sooner. And maybe you want to start a new career.

Maybe you want to open a business. Maybe you want to do something completely different than you're doing now. Another pro is it potential to bridge the gap until other retirement income kicks in. And remember, because of this rule of 55, it's very important you understand this. It only applies to 401(k) money. So if you got money in an IRA or something else, it doesn't apply to that.

As always, with pros come cons. And that's the first con. I just mentioned it. It only applies to your current employer's 401(k). It doesn't apply to prior employers unless you're able to roll it into their 401(k) and everybody's plans are different. And not all 401(k)s offer this option. So you've got to check the details.

You've got to dig in deep with your HR person. And here's the thing, like we mentioned, withdrawals are still subject to income tax. You're going to pay federal and state taxes. There's no way of getting out of that. Another big con. You've got to really consider this. There is a huge risk of depleting retirement savings too quickly. See, at 55, it's all about having that intentional spending plan to make sure you don't run out of money in retirement.

Let's get back to talking about my client Barry. So for Barry, using the Rule of 55 created a financial windfall for him. He was able to retire a year early. He was beaming when we figured this out. He used his 401(k) funds to bridge the gap until his other retirement income sources kicked in. And this gave him the freedom.

Now what did Barry do? He started a small consulting business. He was able to work on his own terms without the stress of that corporate job. But here's the thing you got to understand. It's crucial to approach this strategy with caution. It worked great for Barry. It might not be the best choice for you.

It might not be the best choice for everyone. And that's why it's so very essential to consult with a financial advisor who can help you weigh the pros and cons based on your unique situation. There's no cookie cutter approach to this. And I'm going to mention now, you can schedule a call with me a bit later to help you through this. Let's take a minute to recap.

Cause there's a lot that I dropped on you there. As we said, the Rule of 55 can be a powerful tool for those looking to access their 401(k) funds penalty free before 59 and a half. Again, it requires careful planning. It requires consideration of your overall financial picture. And like I said, I hope you heard this. Just because you can access these funds doesn't mean you should.

And it certainly doesn't mean you should withdraw everything at once. I had a client do that one time. That was a disaster. The key to this is to create a sustainable withdrawal strategy that will support you throughout your retirement years. You can't just look at it in the short term. Now don't forget to tune in tomorrow when we'll be discussing "How much money do I have to have saved to cover some healthcare costs in retirement?"

Let me tell you right now, I was just talking to somebody about this a few minutes ago. This is a crucial topic that goes hand-in-hand with today's discussion on early retirement planning, because not only do you have to plan for the income, but you've got to plan for the expenses and people are sometimes overwhelmed by these medical expenses. Maybe you're feeling overwhelmed by the complexities of retirement planning. Or you're wondering whether the Rule of 55 might be right for you.

I'm here to help you. Many of my clients feel frustrated. They feel confused by the maze of retirement rules and regulations. They're looking for someone to guide them through this complex landscape and help them make the best decisions for their future. And let me tell you, that's where I come in.

I can work with you to create a personalized retirement plan that takes into account strategies, like the Rule of 55, along with your unique and I mean that your unique financial situation and goals. So whether you're looking to retire early, maybe you're looking to start a new business or simply ensure you're on the right track to a comfortable retirement, I'm here to help you navigate these important decisions. Let me tell you about my process and how I help you find that financial security. First thing we're going to do. When you schedule that "Book a call with Ralph", we're going to assess where you are.

We're going to talk about where you are right now. The second step we're going to do, is we’re going to identify your dreams. We're going to talk about those big, hairy, audacious goals and those future plans that mean so much to you. The third step, we're going to align those goals with your faith. We're going to find that balance, that balance between faith and finances. Because that's what it all comes down to.

The fourth step is I'm going to help you build a personalized plan. That's going to be your financial roadmap and it's going to be just for you. It's not going to be what, it's going to be just for you, not what somebody else says or to take these five steps or do these three things. The fifth step. We're going to talk about accountability because we all need to seek accountability and that's very important.

And the sixth step, and this is the part that a lot of people leave out. We're going to measure the results. Because if you listen to me, you know what I say all the time, what gets measured gets done. And at that point we might tweak and adjust the plan. So to schedule an appointment with me, just go to askralph.com. When you get there, you'll see a banner and it reads "Book a call with Ralph." You just click on that.

And yes, there is $150 consultation fee. But you got to think of it as an investment in your financial future. And listen, here's the best part. If we're not able to create a personalized plan to exceed your expectations, I'll refund your consultation fee. That's how confident I am and what we do. The insights and the strategies we'll develop together could save you thousands or even tens of thousands of dollars in the long run. So before we wrap up, here's some actionable steps you can take on today's discussion.

I would like to give you concrete things you can do. First thing you want to do. Review your current 401(k) balance and see if it's substantial enough to consider early retirement. You got to start there. If you've not planned, if you're not in a good shape, no reason to even have this discussion. Second thing. Check with your plan administrator to see if your 401(k) allows for the Rule of 55 withdrawals.

As I said, not all of them do. Number three. If you've got that old 401(k) from a previous employer, talk to your broker, talk to a broker and consider consolidating them into your current plan if that's allowed. That way, it's all in one big bunch there. Number four. Yes. I'm going to talk about budgets. Create a budget to see how much you'll need to withdraw from your 401(k) if you were to retire early. You got to start with some facts. Number five. Consult with a tax professional to understand the tax implications of early 401(k) withdrawals in your specific situation. Book a call with Ralph, find somebody you're comfortable with. And number six, start planning your exit strategy if you're considering the rule of 55.

You've got to have a roadmap. You got to have a plan. Remember this. My passion is to help you achieve financial success. That's why I turn on this microphone. I turn on this camera. I play in these episodes out daily. I want to see you live out your dreams and grow in your faith.

That's what gives me, it's my mission. It's what makes me get up in the morning. And I know working together, we can master your finances from a Christian perspective. So as I always end the show, stay financially savvy and may God bless you.

Narrator
00:15:11

Thank you for joining us on the Ask Ralph podcast. And with a simple click to subscribe, we'll invite you back to our next episode. And remember, financial issues don't have to be complicated, just ask Ralph. The information contained in this episode of Ask Ralph is based on data available as of the date of its release.

Saggio Accounting Plus and Ask Ralph Media, Inc. is under no obligation to update this content if changes occur.

Applying this information to your specific situation requires careful consideration of all facts and circumstances, and any information provided is not to be considered as financial, tax or legal advice, please consult your tax advisor or attorney before acting on any material covered.