"Leave your job in the year you turn 55 or older, and Uncle Sam will cut you some slack on the early-withdrawal penalty." We know that many people are retiring early, leaving jobs to start new ventures and changing jobs in their 50's. This is something that did not happen before the Baby Boomers who are living active thriving lives well past their 50's. Here's great info regarding your 401(k).
The rule for tapping a 401(k) without incurring the 10% early-withdrawal penalty requires that you are at least age 59½, but there's an exception. If you leave your employer in the year you turn 55 or older, there's no penalty. Even so, you'll still owe tax on the withdrawal. As a result, a $10,000 payout at a 25% tax rate will cost you $2,500. However, there's no $1,000 early-withdrawal penalty tacked on to this.
It doesn't matter how you separate from service. In fact, retiring, being laid-off, or even termination will spare you the penalty. Provided you're 55 by the end of the year you leave the job, the rule applies, says the Kiplinger's article, "When You Can Tap a 401(k) Early With No Penalty."
If you were to leave your job in January and turn 55 in December, the 401(k) payouts anytime during the year are penalty-free. However, if you retire in December and turn 55 the next January, you'd be hit with the penalty until age 59½.
Reaching age 55 or older in the year you leave is the trigger, not just your 55th birthday. So if you were to leave a job at age 50, you couldn't tap that 401(k) penalty-free until you reach age 59½. However, if you leave an employer at age 55 to work for another company and then leave the second position at age 57, you could withdraw from both 401(k)s penalty-free. You left both companies in the year you turned 55 or older.
This exception may come in handy for some early retirees who need to use the funds in their 401(k) for living expenses. One thing to keep in mind: this exception from the penalty is lost if you rollover your 401(k) to an IRA. Once the money goes into the IRA, the earliest age for penalty-free withdrawals is back to age 59½.
An IRA, in contrast, has more investment options than a 401(k). You could split the 401(k) for a better result. For example, if you were to retire at 55 with $1 million in your 401(k), and you want to withdraw $50,000 annually for the next five years, you could leave $250,000 in the 401(k) to take advantage of the penalty exception and rollover $750,000 into an IRA to take advantage of other investment choices.
Ask your benefits manager for the details and rules of your 401(k), as there are some plans that don't allow partial withdrawals or periodic distributions.
Reference: Kiplinger's (May 2016) "When You Can Tap a 401(k) Early With No Penalty"