i401k and the rule of 55

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jbreittling
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Joined: Sun Jul 15, 2012 9:48 pm

i401k and the rule of 55

Post by jbreittling »

Hi everyone. I've been doing some research in the BH wiki, via google and also called Vanguard, but haven't been able to pin down answers to a few retirement planning questions I'm trying to figure out.

My retirement $ is currently tied up in a SEP IRA and an i401k (both with Vanguard). I'm about to rollover my SEP $ into my i401k so that all of my $ is in the i401k as I understand the rule of 55 does not permit early (prior to 59.5) withdrawals penalty free from an IRA.

I'd like to confirm a few things about the rule of 55 and hoping folks here can point me in the right direction.

1. I just want to ensure that the rule of 55 allows early distributions, penalty-free, from an i401k. All of the reading I've done the articles simply refer to '401ks', they never mention the 'i' 401ks specifically. Can anyone confirm i401ks are eligible for the rule of 55?
2. I'm currently self-employed, so my plan is to simply shut down the business with my state when I turn 55 which I believe makes me eligible for the early withdrawals because I 'left my employer' who runs my i401k in the year I turned 55. Does anyone know if I'm not correct in my understanding of how to do this?
3. If I can't take early withdrawals from an i401k, would I simply need to find a new employer when I turn 55, quickly roll-over my i401k to their 401k, and then terminate from the company in order to be eligible for the early penalty-free withdrawals? Said another way, are there any time requirements about how long you had to have been in the 401k with your employer before you terminate and then look for the rule of 55?
4. Any suggestions on how to actually do this when the time comes so that I don't screw it up!

I read through this wiki but couldn't find any specific answers to the above. And neither google nor Vanguard was able to help clarify.
https://www.bogleheads.org/wiki/Solo_401(k)_plan

Any thoughts out there?

edit added #4
terran
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Re: i401k and the rule of 55

Post by terran »

I don't don't have a source for this, but logically, here's the problem I see with using the rule of 55 with an individual/solo 401(k):
  1. Maintaining a 401(k) requires a sponsoring business.
  2. The sponsoring business that maintains an individual 401(k) must not have any employees other than the owner(s) and their spouse(s).
  3. For a business to exist it must have a profit motive.
  4. One must separate from service to the business that sponsors the 401(k) in or after the year they turn 55 to take penalty free contributions from the 401(k)
  5. The money must remain in the 401(k) until withdrawn to apply the rule of 55, it can't be rolled over to an IRA.
So, how can one say that they own a business that has a profit motive if they also say they're the only employee of that business and they no longer work for the business? And if there's no longer a business because the only employee of the business no longer works for the business and there's therefore no profit motive then there's no business to sponsor an individual 401(k), so the individual 401(k) must be terminated and rolled over to an IRA. If there's no active 401(k) then the rule of 55 can't apply since it only applies to money withdrawn from a 401(k).

Edit: As you suggest, if you can find an employer with a 401(k) you'd be happy to leave your money in until you turn 59.5 and that will let you roll your individual 401(k) into the plan (some don't allow IRAs, and since individual 401(k)s aren't ERISA plans I could see the same applying to them) and you want to jump through the hoops of applying, rolling over and quitting then this plan could work. Also make sure you find an employer that allows partial withdrawals as some only allow full withdrawals (intended to be rolled over to an IRA)

There are, however, other ways of accessing money in retirement accounts early before you turn 59.5.
Last edited by terran on Fri Sep 17, 2021 9:56 am, edited 3 times in total.
pizzy
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Re: i401k and the rule of 55

Post by pizzy »

terran wrote: Fri Sep 17, 2021 9:51 am I don't don't have a source for this, but logically, here's the problem I see with using the rule of 55 with an individual/solo 401(k):
  1. Maintaining a 401(k) requires a sponsoring business.
  2. The sponsoring business that maintains an individual 401(k) must not have any employees other than the owner(s) and their spouse(s).
  3. For a business to exist it must have a profit motive.
  4. One must separate from service to the business that sponsors the 401(k) in or after the year they turn 55 to take penalty free contributions from the 401(k)
  5. The money must remain in the 401(k) until withdrawn to apply the rule of 55, it can't be rolled over to an IRA.
So, how can one say that they own a business that has a profit motive if they also say they're the only employee of that business and they no longer work for the business? And if there's no longer a business because the only employee of the business no longer works for the business and there's therefore no profit motive then there's no business to sponsor an individual 401(k), so the individual 401(k) must be terminated and rolled over to an IRA. If there's no active 401(k) then the rule of 55 can't apply since it only applies to money withdrawn from a 401(k).

There are, however, other ways of accessing money in retirement accounts early before you turn 59.5.
+1 These are my thoughts exactly.
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Lee_WSP
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Re: i401k and the rule of 55

Post by Lee_WSP »

You'll need to terminate the solo k once you terminate the business, so you'll want to roll it over into an IRA and do a Roth ladder.
deikel
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Re: i401k and the rule of 55

Post by deikel »

SEPP IRA and rule 72t - worth reading
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.
livesoft
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Re: i401k and the rule of 55

Post by livesoft »

401(k) plans do not have to allow the OP's "Rule of 55", but may allow it. One has to consult the 401(k) plan document. I know that my TDAmeritrade individual 401(k) does not have the Rule of 55 in the plan document, so my i401k does not allow it. And my plan does not even allow in in-service withdrawal until age 62. My spouse's 401(k) plan did not allow in-service withdrawals no matter what the age until the plan was changed a couple years ago.

My i401k plan document is 75-pages of legalese and I have read it. Have you got a copy of your i401k plan document?
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terran
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Re: i401k and the rule of 55

Post by terran »

livesoft wrote: Fri Sep 17, 2021 4:02 pm 401(k) plans do not have to allow the OP's "Rule of 55", but may allow it. One has to consult the 401(k) plan document.
This isn't really true. The rule of 55 is simply an IRS rule that says any withdrawal taken from a workplace retirement plan sponsored by an employer you separated from in or after the year you turned 55 doesn't incur an early withdrawal penalty on the distribution. There isn't anything the plan needs to allow/not allow. What a plan can restrict, however, is what sorts of distributions it will allow. If the plan only allows full distributions then this limits the usefulness of the rule of 55 for that plan since you can't then take a penalty free distribution of part of your balance every year to use as spending money.
livesoft
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Re: i401k and the rule of 55

Post by livesoft »

^THanks for the clarification.
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MsPickles
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Re: i401k and the rule of 55

Post by MsPickles »

OP,

I had the same question and found limited information.

Here is a link to a solo401k (i401k) plan provider that addresses the question and is in alignment with terran’s response.
https://www.mysolo401k.net/age-55-rule ... ment-plan/
Alan S.
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Re: i401k and the rule of 55

Post by Alan S. »

Solo K plans have now been utilized plenty long enough for the IRS to state a position on the age 55 penalty exception. They have not done it, which invites taxpayers to test the penalty exception by claiming it.

The prior post has a link which includes entirely logical comments by Mark Nolan. No one can provide any tax code or IRS Regs sources that either validates the exception or invalidates it. Logical arguments can be presented for either position. So if you claim the exception with a 1099R coded 2 or a 5329 filed to override a code 1, you may or may not receive a challenge from the IRS.

If you claim the exception, it may be of limited value since cessation of employment with a solo K plan will often trigger a lump sum distribution for which the income taxes due could be high enough to offset the savings from the penalty waiver.
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