Jason R. Escamilla, CFA
October, 2025 draft version
Early Retirement Withdrawals: Before Age 59½
IRA vs. 401(k)
- IRA No age requirement on SEPP (substantially equal periodic payments)
- SEPP must last 5 years or to 59½, whichever is longer.
- 401k The Rule of 55 is for employer plans (401k, etc.).
- If qualified, (separate at/after age 55) you have flexible, penalty-free withdrawal potential.
- California 2.5% early distribution tax may also be waived when the IRS 10% penalty is waived.
- Income tax and Roth ordering rules still apply.
Highlights
| Topic | IRA | 401(k) |
|---|---|---|
| Age requirement | No age requirement SEPP must run for the longer of 5 years or until 59½.IRS SEPP | Notice 2022-6 | Rule of 55 applies after separation in/after the year you turn 55 (or age 50 for certain public-safety employees).IRS Topic 558 |
| Avoiding the federal 10% penalty | Use SEPP (72(t)) or IRA-specific exceptions (first-home ≤ $10k, higher-ed, unemployment health premiums).IRS exceptions | After qualifying separation, Rule of 55 applies; some 401k plans also allow SEPP.Topic 558 |
| Partial-account strategy | Allowed A SEPP applies to a single IRA. Many people first carve out a new IRA dedicated to the SEPP. No additions/extra withdrawals after start of SEPP.SEPP Q&As | n/a Rule of 55 doesn’t force a commitment; distributions follow plan rules.Topic 558 |
| 401(k) Plan termination & Rule of 55 | n/aIRS exceptions | If you qualified under Rule of 55, you can still take penalty-free distributions directly from the terminated plan. Rolling to an IRA removes Rule of 55 protection.Topic 558 |
Where IRS relief may not equal California relief: California does not conform to every federal exception. Always check the latest FTB 3805P instructions.FTB 3805P (2024)
Detailed Comparison — Early Access Rules (IRA vs. 401(k))
| Topic | IRA | 401(k) |
|---|---|---|
| Age-based exception at a glance | Start at any age SEPP is available at any age; must continue ≥ 5 years or to 59½, whichever is longer.IRS SEPP | Rule of 55: penalty exception for plan distributions after separation in/after the year you turn 55 (or 50 for qualified public-safety).IRS Topic 558 |
| Primary early-access path | SEPP methods: RMD, fixed amortization, fixed annuitization; interest cap ≤ max(5%, 120% mid-term AFR); one-time change from fixed → RMD.Notice 2022-6 (PDF) | Rule of 55: penalty-free plan access post-separation; SEPP is possible if plan allows.Topic 558 |
| Flexibility of withdrawals | Rigid Extra/insufficient amounts before the end date = modification → retroactive 10% penalty + interest.SEPP Q&A 9 | Full Flexibilty No federal penalty-based caps (income tax still due). Plan may limit partials/frequency.Topic 558 |
| SEPP modification rules | Rigid Once started, SEPP cannot be modified without retroactive penalties. One switch is allowed → to the RMD method. (Required Minimum Distribution) Death/disability ends a SEPP without penalty.IRS SEPP | Notice 2022-6 |
SEPP RMDs Required Minimum Distributions on a SEPP at age 50: ~2.9% at age 55: ~3.4% at age 57: ~3.6% at age 60: ~4% See more ages | How RMDs work |
| Roth mechanics | Roth IRA: ordering = contributions → conversions (5-yr clock) → earnings. Qualified = 59½ + 5-yr rule (or death/disability/first-home up to $10k).Pub. 590-B | Roth 401(k): Rule of 55 can waive penalty; earnings still must satisfy 59½ + 5-yr rule for tax-free treatment.Pub. 590-B |
| Taxation of distributions | Traditional: ordinary income. Roth: contributions tax/penalty-free; earnings taxable if not qualified and no exception.Pub. 590-B | Traditional 401(k): ordinary income. Roth 401(k): earnings tax-free only if qualified (59½ + 5-yr); otherwise taxable portion.Pub. 590-B |
| Partial-account strategy | SEPP is per-account; you can carve out a separate IRA to limit the commitment; no additions/extra withdrawals after start.SEPP Q&As | No commitment required by penalty rules; plan terms control partials and installments.Topic 558 |
| How to claim the exception | Use Form 5329 if 1099-R doesn’t show the correct exception.IRS exceptions / Form 5329 | Federal: same. California: compute/report on FTB 3805P.FTB 3805P form (PDF) |
| California 2.5% overlay | Waived for SEPP and other CA-recognized exceptions; CA may not conform to every federal exception.FTB 3805P (2024) | Waived when Rule of 55 applies (qualified plan).FTB 3805P (2024) |
| Plan termination & ongoing access | n/a SEPP | If the 401(k) is terminated, you may take distributions directly from the plan penalty-free if you qualified under Rule of 55; once rolled to an IRA, Rule of 55 no longer applies.IRS Topic 558 |
| SEPP account balance changes | Once a SEPP has started, the account is “frozen.” No new contributions, rollovers in, or partial transfers/rollovers out are allowed. Doing so is a modification and triggers retroactive penalties. Under the RMD-based SEPP, annual payments still recalc each year on the natural Dec 31 balance — but you cannot manipulate that balance by moving funds in or out.IRS SEPP | Notice 2022-6 | IRC §72(t)(4) | Rule of 55 distributions do not impose this restriction. You can move money in/out of other accounts freely, as long as the separation and age conditions are met. Plan-specific rules may still limit withdrawals.IRS Topic 558 |
Key Differences: IRA vs. 401(k)
IRA: SEPP 401(k): Rule of 55
| Feature | IRA | 401(k) |
|---|---|---|
| Age cutoff for penalty-free access | SEPP: no age requirement Payments must run ≥ 5 years or to 59½ (whichever is longer).IRS SEPP |
Rule of 55 after separation (or 50 for qualified public-safety employees) from the plan.IRS Topic 558 |
| Access method | Rigid SEPP requires substantially equal periodic payments; modifications trigger retroactive 10% + interest.SEPP Q&A 9 | Flexible partials/lump sums per plan rules; penalty exception applies after qualifying separation.Topic 558 |
| Partial-account strategy | Allowed Carve out a separate IRA and base SEPP on that account only; no additions/extra withdrawals after start.SEPP Q&As | No formal commitment; distribution options may be limited by plan.Topic 558 |
| Roth treatment | Roth IRA: contributions always tax/penalty-free; earnings need a qualified distribution (59½ + 5 years) or an exception.Pub. 590-B | Roth 401(k): Rule of 55 can waive penalty; earnings still need 59½ + 5-year rule for tax-free treatment.Pub. 590-B |
Flowchart — Using Rule of 55 When a Plan Terminates
Separate from employer in/after age 55 (50 public-safety)?
If YES → you qualify for Rule of 55 on that plan.
If YES → you qualify for Rule of 55 on that plan.
→
Plan terminated by employer?
If YES → distributions allowed from plan on termination.
If YES → distributions allowed from plan on termination.
→
Decide
- Take distributions from the plan (keeps Rule of 55)
- Roll over to IRA (Rule of 55 lost)
→
If distribute from plan
No 10% penalty (federal); CA 2.5% generally waived.
No 10% penalty (federal); CA 2.5% generally waived.
→
If roll to IRA
Rule of 55 no longer applies; use IRA exceptions (e.g., SEPP) to avoid penalty if under 59½.
Rule of 55 no longer applies; use IRA exceptions (e.g., SEPP) to avoid penalty if under 59½.
Explain it to a 10-year-old
IRA if you take money early and avoid the penalties, you must promise to take the same kind of payments every year for a while (that promise is called a SoSEPP or SEPP).
401(k) if you leave your job at 55 (or 50 for some public‑safety workers), you can take money without the extra penalty.
You still pay income taxes, but the extra penalty can be avoided. California has its own extra fee (2.5%), and it usually goes away when the IRS rules say so—except in a few special cases.
Technical note for experts
§72(t)(2)(A)(iv) SEPP safe harbors per Notice 2022-6 (RMD, fixed amortization, fixed annuitization); permitted rate ≤ max{5%, 120% mid-term AFR} using either of the two months preceding first payment; one-time change from fixed → RMD; each SEPP is per-account; additions/extra distributions = modification under §72(t)(4). Rule-of-55 (Topic 558) applies to qualified plans (not IRAs) on separation in/after the year reaching 55 (50 QPSE). CA 2.5% generally waived where federal exception applies; explicit CA exceptions include 01 (55/50 separation) and 02 (SEPP). IRS SEPP • Notice 2022-6 • FTB 3805P (2024)
Last update: September, 2025
