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Retiree Tax Tip: The Age 55 Exception for 401(k)s

How to avoid the 10% early-withdrawal penalty when you tap your former employer's 401(k).

Generally, taxpayers can't tap their retirement accounts penalty free before age 59 1/2. But like many rules, this one has an exception.

If you separate from service at the age of 55 or older, you can tap your former employer's 401(k) free of the 10% early-withdrawal penalty. You will still owe taxes on the money if it's withdrawn from a traditional 401(k). If you take out $20,000 at a 22% tax rate, for example, you'll owe $4,400 in ordinary-income tax, but you won't owe a $2,000 early-withdrawal penalty.

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You can qualify for the relief regardless of whether you retired or were laid off. You just have to turn 55 by the end of the year you leave your job.

But beware: If you roll that 401(k) to an IRA when you leave the company, you'll forfeit the age 55 exception. You'll have to wait until you turn 59 1/2 before you can tap the money in the IRA penalty-free.

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