The double nickel year has potential for allowing you to tap your 401(k) without an early withdrawal penalty, but you have to know exactly how it works to avoid problems.
There's one exception to the rule that you must be at least 59 ½ to tap your 401(k) without incurring a 10% early-withdrawal penalty, but you have to tread carefully. If it is the year you turn 55 or older and you leave your job, there's no penalty. You will still owe tax on the withdrawal—a $10,000 payout at a 25% tax rate will still cost you $2,500. There's no free lunch, even here. But, the good news is you don't get hit with a $1,000 early withdrawal penalty.
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. But 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. But remember: 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). One 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.
One caveat—and it's a big one: not every retirement plan allows for partial withdrawals or periodic distributions. Make an appointment to sit down with your benefits manager to review all of the specifics for your company's 401(k).
Reference: Kiplinger's (May 2016) "When You Can Tap a 401(k) Early With No Penalty"