Avoid IRA Early Withdrawal Penalty With Substantially Equal Periodic Payments (SEPP)

In a perfect world, when you open an individual retirement account (IRA), you won't make withdrawals before the age of 59 ½.

However, life does not always go according to plan.

Sh*t happens.

In most cases, if you withdraw funds from your IRA before the age of 59 ½, the Internal Revenue Service will consider it an early distribution. That means your funds are subjected to regular income taxes as well as an additional 10% penalty.

However, this is not true in all cases.

You down with SEPP?? (Yeah you know me) ...

Substantially Equal Periodic Payments (SEPP)

If you are facing a short-term financial crisis, an early IRA withdrawal should not be your first course of action. However, if you are considering using your retirement account, the substantially equal periodic payment (SEPP) gives you the chance to take an early distribution without having to pay hefty taxes.

But you have to make sure you understand the SEPP rules.

Understanding Rule 72(t)

Rule 72(t) refers to code 72(t), section 2, which specifies exceptions to the early-withdrawal tax that allow IRA owners to withdraw funds from their retirement account before age 59½, as long as SEPP regulations are met.

To take advantage of this rule, you must take at least five substantially equal periodic payments (SEPPs), and the amount of the payments depend on the your life expectancy (calculated by IRS-approved methods). These payments must thus occur over the span of five years or until the owner reaches 59½—whichever period is longer.

There are some things to know before you opt for using the SEPP method for an early IRA distribution. These include:

  • There are no age restrictions under a SEPP
  • All payments must be “substantially equal,” which means that you cannot modify them every year
  • Payments must be computed as if you were intending to distribute your IRA’s funds over the course of your entire life (or the combined life of you and your spouse in a joint account)
  • You cannot discontinue or alter your payments for at least five years
  • If you have not turned 59 ½ after those five years have passed, you must wait until you reach that age to make any changes

IRS-Approved SEPP Calculations

The IRS has three approved ways of calculating your SEPP amounts. All three can result in varying payments. By offering these various calculation methods, the IRS allows you to pick the repayment plan that works best for you. These options include Amortization, Annuitization, and Required Minimum Distribution (RMD) methods.

Reach out if you want to know more. We can answer your questions!

Last Updated: 
June 14, 2018

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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