By Ryan Martin and Lauren Hunt

Substantially Equal Periodic Payment Plans… that is a “mouthful” of a strategy, but the details of such planning don’t have to be complicated.

Tax-deferred accounts such as IRAs provide an excellent opportunity to accumulate funds for retirement. However, in certain circumstances when it might become necessary or desirable to utilize these qualified retirement plan accounts before age 59½, it is important to be aware of the consequences and opportunities for making early withdrawals. To discourage investors from prematurely accessing funds saved for retirement, the IRS generally imposes a 10% penalty on early withdrawals from 401(k) plans, 403(b) plans and individual retirement arrangements (IRAs) for any person who has yet to reach age 59 ½.

Provided that certain guidelines are followed, the IRS provides for a tax-advantaged, penalty-free option for those that find themselves needing distributions from these accounts before the prescribed retirement age. Under Internal Revenue Code Section 72(t), a person younger than age 59½ can take substantially equal periodic payments (SEPP) from qualified plans and IRAs without the imposition of the 10% penalty tax.

What is a substantially equal periodic payment (SEPP) plan and how does it work?

Under this exception, the participant effectively annuitizes his or her account using one of three methods provided by the IRS for calculating the annual withdrawal amount. Payments can be fixed or they can vary from year to year based on certain formulas. In addition, the following rules also apply:

  • Payments must be made at least annually.
  • Payments must be substantially equal.
  • Payments must last for at least five full years or until the participant turns 59½, whichever period is longer.
  • Payments cannot be modified before the participant reaches age 59½ or within five years of the date of the first payment, whichever period is longer.
  • In the case of a qualified plan (but not an IRA), payments must begin after the participant separates from service.

What are the drawbacks of a SEPP?

While SEPP payments provide early access to retirement funds, that flexibility comes with the requirement of following the SEPP guidelines. Because you must continue with the same distribution schedule for five years or until you reach age 59 ½, whichever period is longer, you’ll want to think about this plan with longer-term perspective (versus a short-term fix). If you terminate or substantially modify your SEPP within the given time restrictions, you will have to pay the early withdrawal penalty that you previously avoided, plus interest on deferred penalties from prior tax years. The IRS allows an exception to this rule for deceased taxpayers or those who become permanently disabled. After the end of the required withdrawal period, however, you may change or stop the withdrawals altogether.

Final Thoughts

There are many items to consider when entertaining whether a SEPP is right for you. While the details and planning considerations extend beyond this summary, the strategy can prove very advantageous in the right situation.

As always, we recommend consulting with an appropriately credentialed professional before making any financial or tax-planning related decision.

© 2021 Moneta Group Investment Advisors, LLC. All rights reserved. These materials were prepared for informational purposes only. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. Past performance is not indicative of future returns. These materials do not take into consideration your personal circumstances, financial or otherwise.