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Taking Advantage of Substantially Equal Periodic Payments (SEPPs)

SEPPS Offer Flexibility to Early Retirees or Those Who Need Long-Term Income, But Calculations Can Be Tricky

By David Fisher

(LifeWire) - In general, if you take money out of a 401(k), an individual retirement account or any other qualified retirement plan before you turn 59 1/2, you'll owe a 10% penalty on top of your income tax. The 10% penalty rule has a big exception, however, for people who want to take money out early: substantially equal periodic payments.

Rules That Govern Substantially Equal Periodic Payments

Created by Internal Revenue Code Section 72(t), the SEPP rule lets account-holders withdraw money from their retirement accounts at any age, penalty free, if they follow certain rules.

A SEPP allows for withdrawals every year in roughly equal amounts that are based on life expectancy and an interest rate the IRS deems reasonable. (The interest rate accounts for the likelihood that the account will grow while it waits for you to draw money out over time.) Once withdrawals start, they must be taken for at least five years or until age 59 1/2, whichever is later.

Account-holders with IRAs can take SEPPs at any time, but account-holders with employer-sponsored plans like 401(k)s, SEPs or SIMPLEs can no longer be employed by the sponsoring company.

Those who have two or more retirement accounts can convert any number of them into SEPP payments, but they are not required to convert all.

Once an account is converted, there can be no further withdrawals taken or contributions made until the SEPP is over.

Break any of these rules, and the IRS will slap a 10% penalty on all withdrawals taken under the plan.

Calculating Substantially Equal Periodic Payments Withdrawls 

All three methods accepted by the IRS for calculating SEPP withdrawals rely on life expectancy tables published in IRS Publication 590. Interest rates can't exceed 120% of the Federal Annual Mid-Term Rate published monthly by the IRS.

  • Amortization: Calculates equal annual payments using the life expectancy of the account-holder or a beneficiary and a selected interest rate.
  • Annuitization: Similar to amortization, but uses an IRS annuity factor along with life expectancy and interest rate to calculate equal annual payments.
  • Required minimum distribution: Divides the account value by life expectancy. Refigured every year to account for fluctuations in account value.

In most cases, annuitization and amortization will result in much larger withdrawals than minimum distribution.

Benefits of Substantially Equal Periodic Payments

Penalty-free SEPPs offer great flexibility to people who want to retire early or need an extra long-term income stream, but they are complicated.

An online calculator can help you figure the right withdrawal amount to take, but for most people the calculation is best left to a tax professional.

LifeWire, a part of The New York Times Company, provides original and syndicated online lifestyle content. David Fisher is a freelance writer based in Bend, Ore. In addition to 25 years as a writer and editor, he has worked as a professional financial adviser.

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