What Is SEPP (Substantially Equal Periodic Payment)?

Typically, you can’t withdraw your retirement funds prior to age 59 ½ without incurring an early withdrawal penalty of 10%. There are a few exceptions to this rule. One of them is to take substantially equal periodic payments (SEPP) from your IRA, 401(k), or other qualified retirement account. Let’s break down how SEPP plans work, some methods to calculate your withdrawals, and the pros and cons of accessing your funds early through a SEPP plan.

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How do SEPP plans work?

A SEPP plan is a strategy that can help you avoid the 10% early withdrawal penalty when you take distributions from your retirement account early. Substantially equal periodic payments (SEPP) are based on your life expectancy. There are three IRS-approved methods that can be used to calculate your substantially equal payments, outlined below. These three methods are not the only allowable methods to calculate your SEPP, but they are automatically approved by the IRS.

You have to use a life expectancy or mortality table for all three methods. You will also need to select an interest rate for the fixed amortization and fixed annuitization methods. The interest rate should be no more than 5%, or 120% of the federal mid-term rate for the two months immediately prior to the first month of the SEPP plan, whichever is greater.

You will need to know your retirement account balance to calculate the SEPP under each method. For the RMD method, the account balance is typically considered to be the balance at the end of the prior calendar. For the fixed amortization or fixed annuitization methods, the account balance is “determined in a reasonable manner based on the facts and circumstances.” For example, the account balance could be calculated as the last statement balance plus contributions and earnings, minus withdrawals and losses.

Specific Requirements

There are specific rules that you must follow under the SEPP strategy to avoid additional penalties.

1. If your retirement plan is with an employer, you must be separated from service with that employer before you can set up a SEPP plan.

2. Once you begin a SEPP plan, you can no longer contribute to the account or take other distributions outside the designated SEPP distributions.

3. You can only have the one SEPP plan in effect for the account in a tax year.

4. You cannot modify the SEPP plan until the later of:

   • Five years after your first payment under the plan.
   • You reach age 59 ½.

How to calculate SEPP plan withdrawals

Here are three allowable methods to calculate your SEPP distributions. Let's assume for these calculations that:

• You are 47 years old.
• Your IRA balance is $500,000.
• You are using your own life expectancy only.

Required Minimum Distribution Method

Using the RMD method, you will divide your account balance by your life expectancy using your attained age prior to the RMD calculation. Using the single life table, you calculate your life expectancy at age 47 to be 39 years. Divide your $500,000 account balance by 39 to arrive at an RMD of $12,820.51. The following year, you would recalculate your RMD using the following end-of-year IRA balance and life expectancy based on an attained age of 48.

Fixed Amortization Method

The fixed amortization method uses a set amortization factor, based on your chosen interest rate and calculated life expectancy from above. You can calculate the amortization factor by taking the present value of $1 per year payable at the end of the year. You then divide the $500,000 account balance by the resulting figure to arrive at your annual distribution amount. Each subsequent year under the fixed amortization method, your distribution amount remains the same.

Fixed Annuitization Method

The fixed annuitization method uses a set annuity factor, based on your chosen interest rate and calculated life expectancy from above. You can calculate the annuitization factor by taking the present value of an annuity of $1 per year payable at the end of the year. You then divide the $500,000 account balance by the resulting figure to arrive at your annual distribution amount. Each subsequent year under the fixed annuitization method, your distribution amount remains the same.

Pros and cons of Substantially Equal Periodic Payment (SEPP)

Advantages of SEPPs

A SEPP is a great strategy that can help people who need to tap into their retirement accounts prior to typical retirement age. If you find yourself in need of money before you could usually access these funds, this is a great option to avoid the early withdrawal penalty. Substantially equal periodic payments make it easy to budget your finances by projecting your yearly distributions out into the future. This is especially true with the amortization or annuitization methods, where the payments remain the same every year.

Once your account has been open for five years, or you reach age 59 ½, whichever is later, you will be able to change your distributions. This allows you to modify your distributions to a level that is more sustainable once you are actually at standard retirement age.

Disadvantages of SEPPs

Once you begin a SEPP plan, you cannot change your distributions or calculation method until you have had the account open for five years, or you have reached age 59 ½, whichever is later. That means, if you start a SEPP plan at age 45, you will have 14 ½ years of distributions that you cannot modify—even if your life circumstances have changed considerably in the meantime. If you change your distributions prior to that date, an additional recapture tax applies. There is an exception to this rule that allows a one-time change from a fixed method—like the amortization or annuitization methods—to the RMD method.

Another major downside is that your retirement account will no longer continue to grow once you begin a SEPP plan. You are no longer allowed to make any contributions to your retirement account once the SEPPs begin, and your distributions will lower your account balance even further. This negates the tax benefits of allowing your retirement account to grow until retirement.

TIME Stamped: SEPPs can help you avoid a penalty if you need to take early withdrawals from your retirement account

Typically, an early retirement account withdrawal comes with a 10% penalty. With a SEPP plan, you can avoid the early withdrawal penalty by setting up a series of substantially equal periodic payments. However, you need to be certain this is a good move for you down the road. Once you begin a SEPP plan, you can no longer contribute to your retirement account, and your annual distributions will leave you with less in the account for your actual retirement needs. If you do decide to set up a SEPP plan, be prepared to continue with the payments for a minimum of five years or whenever you reach age 59 ½, whichever is later.

Frequently asked questions (FAQs)

Is it possible to take SEPP withdrawals from my 401(k)?

Yes, you can take SEPP withdrawals from your 401(k). However, with a 401(k), you can no longer be employed by the business that sponsors the plan when you begin your SEPP plan. In other words, the 401(k) must be with your former employer. You can’t set up SEPP withdrawals for a plan with your current employer.

Are there any penalties associated with SEPP plans?

There are no penalties associated with SEPP plans if you follow the rules. However, you need to be aware that you cannot modify the plan before you meet the five year minimum holding period or before you reach age 59 ½, whichever is later. Revisions prior to that date are subject to a recapture tax.

How do you set up a substantially equal periodic payments plan?

You can set up a SEPP plan with your financial advisor or retirement provider. Here are three highly recommended retirement providers where you can open a traditional or Roth IRA:

• Robinhood.
• Empower.
• J.P. Morgan.

When you first set up your SEPP plan, you can choose one of the three IRS-approved methods to calculate your payments:

• Required Minimum Distribution Method.
• Fixed Amortization Method.
• Fixed Annuitization Method.

These three methods are not the only allowable methods to calculate your SEPP, but they are automatically approved by the IRS. Other methods may be deemed acceptable as well.