Are you retiring early? Perhaps you’ve planned to use your IRA assets as a source of income at this stage of your life – or maybe you’ve had to stop working temporarily because of a health condition or to care for a loved one. If you haven’t yet reached age 59½, you will generally owe a 10% “early withdrawal” tax on any taxable dollars you take out of your IRA. This is in addition to the regular income tax you would owe on a taxable distribution. You may be able to avoid the 10% additional tax, however, if you set up a Substantially Equal Periodic Payment (SEPP) arrangement.
Setting up a SEPP arrangement provides a way for IRA owners to access their retirement savings before they reach age 59½ and avoid the additional tax.
The Rules
A SEPP arrangement is a series of payments that must continue for five years or until the IRA owner reaches age 59½, whichever period is longer. The payments cannot be stopped or altered, and no contributions or other distributions may be made during the payment period.
Example
If you began taking payments at age 56 on December 1, 2019, you may not take a different distribution or alter the amount of the payment until December 1, 2024 (5 years), even though you turned 59½ in 2022.
If you begin taking payments at age 54 on December 1, 2019, you may not take a different distribution or alter the amount of the payment until July 1, 2025 (6½ years) when you turn 59½.
If the arrangement is modified or stopped before the end of the required payment period, the exception to the 10% early distribution tax is lost and retroactive payments of the tax for each year the arrangement was in place, plus interest, must be made.
There are exceptions to the retroactive tax if the payments are discontinued because of the IRA owner’s death or disability or the IRA assets are depleted as a result of investment losses.
The Payments
The amount of each payment is typically calculated using one of three methods outlined in IRS guidance.
| IRS Method | Calculate payments by… | Type of payment | |
| 1 | RMD | Dividing each year’s account balance by the IRA owner’s life expectancy (or joint life expectancy with designated beneficiary) | Payment amount re-calculated each year (reflects investment gains and losses and shrinking life expectancy) |
| 2 | Amortization | Amortizing the account balance at the start of the arrangement over the IRA owner’s life expectancy (or joint life expectancy with designated beneficiary), using an acceptable interest rate | Payment amount set in first year; same amount must be withdrawn each subsequent year |
| 3 | Annuitization | Annuitizing the account balance at the start of the arrangement using an acceptable interest rate and annuity factor | Payment amount set in first year; same amount must be withdrawn each subsequent year |
Using the RMD method provides a fluctuating payment amount each year that reflects investment gains and losses in the account. The amortization and annuitization methods set the payment amount in the first year and the same amount must be withdrawn in each subsequent year. The calculation method chosen at the outset of the arrangement generally must be continued throughout the duration of the payment period. But, IRA owners are permitted a one-time switch to the RMD method. Payments may be taken annually or more frequently.
A Potential Strategy
Once you begin a SEPP arrangement from an IRA, you cannot take any other distributions from that IRA or roll over money into that IRA until the payment period has ended. One strategy IRA owners have used to protect their options is to split their savings among multiple IRAs and then establish a SEPP arrangement with just one IRA. You may want to experiment with the calculation methods to identify an account balance that will be just enough to meet your payment needs. This strategy protects the remainder of the IRA assets, allowing account owners to withdraw or move additional IRA assets if needed, without triggering the retroactive tax.
You should seek tax advice before setting up a SEPP arrangement to make sure it fits your needs and retirement income goals and to identify all the potential tax consequences.
If you have questions, please contact us at 866-928-9394 or Service@StrataTrust.com.
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