Rule of 55 Question

[DawgMan]

I am a little fuzzy as to how the Rule of 55 works or what I may need to do if I decide to pull $$ from my 401K (or my wife's) before age 59 1/2. A quick google seems to imply I need to be separated from my employer and only applies to assets in your current 401(k) and not money in a former 401(k). Well, here is my situation...

- Currently have wife/myself set up as W2's under an LLC I own (been this way since 2016). Previously, operated same business as a 1099.
- This is my last year of earning any real income and in 2021 (age 57) I plan on starting drawdowns from my investments.
- Plans are/were to keep my LLC alive for the potential one off consulting gig.

Questions...

- If I want to drawdown (without penalty) from my (or my wife's) 401K do I have to dissolve my LLC or fire myself & wife to show the IRS I am "separated from my employer"?
- I have used the same personal 401K as a 1099 and W2. How does the IRS decipher/define a 401K account as "former" or "current" in this case?
- Could I "rehire" myself in the future or go back to 1099 status and generate consulting income since I am no longer an employee of my LLC?

I don't need any of my 401K to live on for the long haul, but trying to make sure I have all my levers set to help minimize the tax impact on RMDs. Significant Roth conversions is an obvious strategy. Another thought is I could fire my wife from the LLC and pull from her 401k.

Anyone have more insight to the nuances of Rule of 55?

 

[pb4uski]

Is your 401(k) plan a traditional 401(k) or safe harbor 401(k) or SIMPLE 401(k)?

Since you say that both you and your DW are participants, I assum that it is not a solo 401(k).

 

[DawgMan]

Is your 401(k) plan a traditional 401(k) or safe harbor 401(k) or SIMPLE 401(k)?

Since you say that both you and your DW are participants, I assum that it is not a solo 401(k).

Well, good question. They were set up probably 15 - 20 years ago as part of a DB plan. The DB piece got maxed out a number of years ago rolling into my 401K. I have contributing to the same 401Ks since then. Would assume traditional but maybe solos?? How would it differ!

 

[pb4uski]

I suspect that the rule of 55 might differ between different types of plans.

I'm more familiar with megacorp plans which would be traditional 401(k). You're eligible for no-penalty withdrawals if you end service in the year that you turn 55:

... Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55...

. If this applies to your plan I think it would be met if you didn't have any W-2 income. My thinking is if you have no W-2 income then you're not an employee.

Another angle might be to take money out as loans rather than as withdrawals... early distribution penalties wouldn't be in play and it wouldn't be taxable income and I suspect as the owner of the business you might have some lattitude in setting the repayment rules.

You should probably have a long talk with your 401k administrator.

https://www.irs.gov/taxtopics/tc558

 

[DawgMan]

I suspect that the rule of 55 might differ between different types of plans.

I'm more familiar with megacorp plans which would be traditional 401(k). You're eligible for no-penalty withdrawals if you end service in the year that you turn 55:
. If this applies to your plan I think it would be met if you didn't have any W-2 income. My thinking is if you have no W-2 income then you're not an employee.

Another angle might be to take money out as loans rather than as withdrawals... early distribution penalties wouldn't be in play and it wouldn't be taxable income and I suspect as the owner of the business you might have some lattitude in setting the repayment rules.

You should probably have a long talk with your 401k administrator.

https://www.irs.gov/taxtopics/tc558

Thanks. I looked at some of the annual paperwork I complete/receive from my administrator and they seem to refer to it as "401K Profit Sharing Plan". Since I am guessing any side gig income would be relatively minimal, my DW would be "fired" at the end of this year, so any desired early 401K access could more easily start with her 401K. I will check with my administrator and accountant, just curious what the group my know about some of the nuances.

Frankly, didn't really think about a loan... will have to dig into the mechanics & pros/cons of that. My thought was load up on Roth conversions starting next year and then either pull other needed income from after tax or one of our 401Ks

 

[USGrant1962]

You can only do Rule of 55 if your plan includes it - IRS allows it, but it is not mandatory for plans to implement. You need to check your Summary Plan Description with your administrator.

And it doesn't really matter but the usual language would be for your wife to retire, not be fired.

 

[pb4uski]

It doesn't have to be a retirement.... you just have to leave service/no longer be an employee... you could be fired, laid off, resign or retire.