What Is Substantially Equal Periodic Payment (SEPP)?
A Substantially Equal Periodic Payment (SEPP) is a payment from a retirement account that meets specific IRS requirements.
The funds are distributed to you as SEPP when you withdraw from a qualified retirement account under Rule 72(t). These regular payments are created over five years or until you turn 59 ½.
A SEPP lets you withdraw funds without penalty from a retirement account before you reach 59 ½.
How Does a SEPP Plan Work?
Setting up the SEPP arrangement is through a financial advisor or directly with an institution.
With a SEPP plan, you can choose any qualified retirement account except the 401(k).
Select among the three IRS-approved methods for calculating your distributions from a SEPP: amortization, annuitization, and required minimum distribution.
Each of these will turn out in a different calculated annual distribution.
In at least two options, the amount you withdraw will be pre-determined and unchanged yearly.
Before the minimum holding expires and you cancel the plan, you will have to pay the IRS all penalties to be waived on the distributions plan and with additional interest.
When to Use a SEPP?
Consider SEPP withdrawals if your financial need is short-term.
A SEPP can be helpful if you need to access your retirement savings early but want to avoid the steep penalties that come with an early withdrawal.
However, once you start SEPP payments, you must continue for a minimum of five years or until you turn 59 1/2.
When failed to be met, this requirement will result in 10% early penalties and interest on the deferred from prior tax years.
How to Calculate SEPP?
There are three methods to calculate SEPP withdrawals. As such, include:
Fixed Amortization Method
The annual payment will be matched for the program in an amortization method without recalculating distributions each year.
This method is determined using the selected life expectancy table and interest rate.
To calculate the amortization method, you must look up the monthly federal mid-term rate.
In this method, three life expectancy tables may be used, such as the single life expectancy, uniform lifetime, and joint and last survivor table.
Fixed Annuitization Method
The fixed annuitization method comprises an account balanced, an annuity factor, and a yearly payment.
The annuitization method calculates a minimum SEPP withdrawal fixed over the five-year rule period.
In the first distribution year, the annual amount calculated is then used for each subsequent year of SEPP withdrawals.
Required Minimum Distribution (RMD) Method
The annual payment of each year, when using the required minimum distribution method, is determined by dividing the current account balance by the taxpayer's life expectancy.
The annual withdrawal amount must be recalculated each year with the new account balance that will change yearly.
The chosen life expectancy table in the first year must continue to be utilized each following year.
Thus, this method considers market fluctuations that impact an account's balance.
Example of SEPP Calculations
Some examples show the annual amounts resulting from each calculation method.
Suppose that Rafael is 45 years of age, has $500,000 in a retirement account, and plans to start SEPP withdrawals.
He will use 3.98% (assuming the federal mid-term rate is 120%) as an interest rate for the amortization and annuitization methods.
The results would be $25,511.57 per year for the amortization method, $25,227.04 per year for annuitization method, and $12,886.60 per year for the minimum distribution method.
Over the next 14 1/2 years, Rafael's financial needs upon taking SEPP withdrawals will be determined by his choice of method.
Also, he needs to consider his expectations of retirement after the age of 59 1/2.
Bottom Line
The substantially equal periodic payments can be a helpful tool to access your retirement savings without being subject to steep penalties.
Before deciding, you must know how each method works and what calculations are involved.
You also must ensure that you continue taking SEPP withdrawals for at least five years or until you reach age 59 ½, or you'll be subject to the early withdrawal penalties.
FAQs
1. What is a SEPP?
A SEPP is an IRS-approved method of withdrawing funds from a retirement account without being subject to an early withdrawal penalty. You can use the SEPP strategy if you have retired or separated from employment and are at least 59½ years old OR if you are still employed but have reached age 55.
2. How much can I withdraw using the SEPP method?
The amount you can withdraw using the SEPP method depends on several factors, including age, life expectancy, and account balance.
3. How often can I withdraw money using the SEPP method?
You can withdraw from your account as often as you like, but you must take at least one withdrawal every year.
4. What are the penalties for withdrawing from a SEPP before I'm 59½ years old?
If you withdraw funds from your retirement account using the SEPP method before you're 59½ years old, you'll be subject to the early withdrawal penalty. The amount of the penalty depends on your age and tax bracket.
5. Can I use the SEPP method to withdraw money from my retirement account even if I'm still working?
Yes, you can use the SEPP method to withdraw funds from your retirement account even if you're still working. However, to do so, you must be 55 years old and have retired or separated from employment.
