Basic question – 120% sepp rates

L1: Basic question – 120% sepp rates
When looking at the ‘120% Midterm Applicable Federal Rates (AFR)’ I want to be sure I understand. I see ranges in the past2 yearsof a little over 1.70% up to around 3.45%. On a 1M portfolio under 72t, I could expect that my withdraws would have ranged from around as low as $17k and as high as $34k? Is that right?
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And follow up: so you never really know what next year will bring, and can’t really depend on set dollar amountsmonth-to-month and year-to-year?
2018-07-31 16:10, By: rory, IP: [198.17.60.35]

L2: Basic question – 120% sepp rates
I did not think a doubling of the allowed 120% rate for the calcs would double the resulting annual payment in a 72T, but I plugged in just one example using a 7/1968 DOB (that was on the screen) and $1 mill, and 3.44% and got Amort (highest payout) of $50,184. Then I changed the Int rate to 1.72% with same age and it yielded $38,921. I would suggest just using calculator and doing same thing with your age and other details, to see specifically what you would get with the differing SEPP INT rates. It is not a linear equation. (BTW- the “investment rate” has no bearing on the outcome. It is just used to predict how much will be left in your IRA each year after the withdrawal)
Once you create a SEPP (72T) plan, you can lock it in to stay with that same annual total payment each year for the entire plan, unless you choose the RMD method that does require annual recalculations, using just your age and new year end balance (no INT rate) for your next year’s payout calc. It also pays out the lowest amount on your portfolio balance.

2018-07-31 16:32, By: Ken, IP: [98.110.192.110]

L3: Basic question – 120% sepp rates
Thanks, that was super helpful.
As I played around with it using my age – 36 – and different ‘120% rates’ I’m finding that the % of portfolio they allow you to take annually varies very little, as your post suggested. Roughly a 1.5% (SEPP interest rate) translates to me getting 3.62% of my portfolio per year, and 3.44% gets me 4.3%.
So my follow up question is from this part of your reply: “you can lock it in to stay with that same annual total payment each year for the entire plan.” So to state that out loud, if I did a $1M calculation on 3/13/82 at 3.44% SEPP % rate, I’m getting an Amortization Method Calc of $43,031 per year. Are you saying that if I elect that at 40, each year until 59.5 I will be locked into a withdraw of $43,031, regardless of changes to the SEPP% rate?
2018-07-31 17:02, By: rory, IP: [198.17.60.35]

L4: Basic question – 120% sepp rates
Yes, that is correct. Most people choose the fixed payment method for the life of the 72T, and Amortization calculation (to get highest payment) since it gives you a guaranteed amount that you can count on each year, and it avoids you getting a lesser amount in years if the SEPP INT Rate goes way down, or when your portfolio takes a large hit, which could also cause a decrease in annually recalculated plans. I did it with two different SEPP plans I had, and in one case, I made a one time change to RMD in last few years, to lower the payment, since I no longer needed that much for next two years. Then I had to recalculate that plan each year on the RMD method.
If you run out of money in the IRA, there is no penalty for not taking your full withdrawal in the last year you have money to withdraw, which could happen in a plan that needs to run for 19+ years.
The downside of starting a SEPP so young, is that you could exhaust a lot of the IRA money before you really need it when you are older. I started at 55 and both plans are completed.
2018-07-31 17:46, By: Ken, IP: [98.110.192.110]

L5: Basic question – 120% sepp rates
Ken,
when you say both plans are completed, you don’t mean exhausted do you?
I’m having a hard time imagining that money I’m withdrawing at 3.5% to 4.5% of total portfolio, without being adjusted upward for inflation, would ever run out. Perhaps if I caught a down market in the early years. But I doubt if I plugged a 4.5% draw into S&P 500 and started right at the top of 2007 that I’d be out of money.
But I’ll test it to be sure.
2018-07-31 18:34, By: rory, IP: [198.17.60.35]

L4: Basic question – 120% sepp rates
Yes, the SEPP distribution will not change, in this case for the 19 years of your plan. The exception would be if you made the one time switch to the RMD method, and while that switch reduces your payout about 35% on average, your actual outcome could be much different since you propose an unusually long plan. For a 19 year SEPP the odds are very high that your annual distribution would not come close to matching your needs in the later years. That causes a risk of busting the plan if you need more money, or if you do NOT need the money the forced distributions tend to drain your IRA and raise your taxes.
Annual recalculation of your amortization plan has been approved by the IRS, and that would require you to use a new interest rate, age and account value every year. That would produce a variable annual distribution. However, the IRS rarely encounters such a plan and it would definitely attract their attention, probably in multiple years, so we do not recommend adopting a recalculated plan. In addition, doing 19 annual calculations obviously increases the risk of an error in any one of them and if such error occurred toward the end of the 19 years, the retroactive penalty and interest charges would be brutal. In short, be very careful here.
2018-07-31 17:50, By: Alan S, IP: [24.117.172.15]

L5: Basic question – 120% sepp rates
Alan,
Thanks for the good reply. You’ve given me a lot to think about.
Generically it is a long plan – 19 yrs. But to that end, Idon’t look at this as the end of my work or my earnings. I’ll certainly earn something every year; some years maybe only $5k, others perhaps $65k+. Regardless, I can’t ever see needing more than $36-$48k in 2018 dollars.
In the early years of the plan I’d be traveling, not working much, enjoying the kids and the wife while they are young. If I SEPP’d-out $40k and only needed $35k, and earned $5k, then I could throw $10k into a taxable account at Fidelity. Multiply that by the first 10 years and I’ve got a bit of money put aside for the later years.
If I went back to work for even two years in my 50s and earned $65k, only needed $35k, but SEPP was locked at $40k, then I’m putting the $70k remaining back into a combination of retirement accounts and taxable accounts.
Another thought I had was to keep maybe $100k of IRA as non-SEPP. 10 years or so into the 19 year plan I could take whatever that money turned into, hardship withdraw it to make a payment on a house, which in the short term reduces my income need, and in the long term (when I sold) would become liquid money.
Regardless, I’ve got a lot more planning to do. Luckily I’ve got a few years to get the details ironed out.
2018-07-31 18:30, By: Rory, IP: [198.17.60.35]

L6: Basic question – 120% sepp rates
Be careful. Your definitions may not be accepted by IRS. For example, just because you plan to have limited income in a given year might not be accepted by the IRS as having a “hardship”. The withdrawals from an IRA for a house is limited to $ 10,000, and it is only for “first time homebuyer”.
I think it would make more sense for you to consider doing conversions in low income years from your Traditional IRA to a ROTH IRA up to the limit in the 12% tax bracket, which is now $ 77,400 of taxable income, which is $ 101,400 in gross income minus $ 24,000 Standard Deduction. This can avoid the 10% penalty for early distributions without getting locked into a SEPP 72-T plan until 59 1/2. Read up on the regulations concerning withdrawals from ROTH CONVERSIONS, which is different from the regulations for withdrawals from ROTH CONTRIBUTIONS.
Also, since you have a long horizon, I would separate your $ 1 million into multiple SEPP 72-T plans, so that if ever necessary to bust a plan, you would only be subject to the cumulative penalty on just that plan. Also, if you keep $ 100,000 in a non-SEPP plan, you could use that in an emergency, and pay the 10% penalty only on that withdrawal, which you would probably be doing in a low income year with a low basic tax rate.
2018-07-31 19:27, By: dlzallestaxes, IP: [173.75.247.117]

L7: Basic question – 120% sepp rates
dlzallestaxes
Thanks for the good reply. I didn’t realize $10k was the limit on the house IRA withdraw. I would have looked into it; it was just an ‘off the cuff’ remark but it’s good to catch it now.
The problem with doing a Roth conversion ladder is the 5 year waiting period. My plan starts in about 5 years, and the next few years I need to max out IRA/401k for college/FAFSA purposes.

Also, later, if I go right up to the $77,400 I end up paying a shit ton in ACA healthcare that I wouldn’t pay at, say, $36k using 72t. So my ‘low income years’ are by design. I’ll save more getting ACA subsidies than the tax break.
But your point is a good one. I’ll need to consider it in light of my circumstances which are very unique.

2018-07-31 20:16, By: rory, IP: [198.17.60.35]

L8: Basic question – 120% sepp rates
I would never plan for anyone’s retirement to be linked to ACA. That law may not survive this or the next administration, let alone until you are eligible for Medicare, which will probably be moved beyond 65 by the time you approach that age.
I wasn’t suggesting that you do a ROTH CONVERSION of $ 1 million all at one time. If you converted $ 50,000 a year for 20 years of low income at 12%, it would cost $ 120,000 at $ 6,000/year in taxes. The amounts of your CONTRIBUTIONS AND/OR CONVERSIONS to ROTH IRA’s are never taxed when you withdraw these amounts.
You are misinterpreting the “after the first 5 years” provision. Only “earnings and appreciation” are taxed, and not until ALL CONTRIBUTIONS & CONVERSIONS are withdrawn. The “earnings and appreciation” on ROTH CONTRIBUTIONS are not taxed once you reach age 59 1/2, as long as they were there for at least 5 years from the year of the FIRST CONTRIBUTION. For ROTH CONVERSIONS, each conversion has its own 5 year holding period. So, once you start a ROTH CONVERSION PROGRAM, you will probably have built up enough by the end of 5 years ( $ 250,000) to sustain whatever distributions you want/need, and to pay the income taxes in additional years as you do further ROTH CONVERSIONS in low income years.
I suggest that you read the IRS regulations on ROTH IRA’s (IRC 408A), and/or discuss with a professional tax or financial adviser.
2018-07-31 21:45, By: dlzallestaxes, IP: [173.75.247.117]

L9: Basic question – 120% sepp rates
DLZ,
Again, thanks very much for the information.
As for ‘depending’ on the ACA, IMHO the only intelligent way to plan for the future is to plan on what is in place presently. The ACA survived the first all-republican congress; I don’t see a more-democratic congress repealing it. If they do I’ll adjust my plan accordingly. But I have to plan for something, and for now I’ll plan for the law on the books.
All of which means that I need to keep income in the $40k-$48k range during those years, and as suchI can’t Roth contribute or convert for 5 years while also needing money to live on. That was my point on the ‘5 years.’
I could set up a Roth Conversion Ladder now, when it doesn’t much matter what my taxable income is. That’s a good idea, and one I’m going to ponder for a day or two before making big moves. It won’t be able to save enough (my ladder will need to be at least $40k/yr, or $200k overall) given my short time frame, but I could easily get that much between some Roth and the eventual sale of my house. Then as I see it, I convert $40k/yr to Roth for 5 years, while I live off of the sale of the house and what Rothput away this year, 2018, which will have aged by then.
Ultimately I’m looking to strike a balance as I very much want to 72t at least some of my income. That really was the point, as I was avoiding 22%-25%-28% during my working years, and I’d very much want to redeem it at 12% during my early retirement. So my eventual plan is likely to be a mix of Roth conversions, sale of house, and 72t.
2018-08-01 12:39, By: rory, IP: [198.17.60.35]

L10: Basic question – 120% sepp rates
I set my SEPP back in 2016 at the age of 36 with a really low mid term rate. Fast forward 2.5 year later I’m not even touchingall of the dividends that come from that portfolio, so I’ve never really touched the principal.
My plan is in my late 40’s I will switch to the RMD method, and this should theoretically let me tap into more of my SEPP balance. I estimate my dividend income from this account should be close to double in that 10-12 year time frame, and even then I may not dip into principal switching to the RMD method.
I have it on my site, but unfortunately don’t think I can post it here.
2018-08-02 01:31, By: brkr12002, IP: [2001:5b0:50c6:5818:105e:5079:c78:777f]

L11: Basic question – 120% sepp rates
BRKR
Could you email me your website address. I’d be very interested to look it over.
r m c v a y @ I b c p . com
2018-08-03 17:30, By: rory, IP: [198.17.60.35]

L12: Basic question – 120% sepp rates
In general, the basic guideline is the “rule of 72” or “rule of 120”. If you divide your assumed “return on investment” (i.e. income yield + growth rate) into 72, gives you the number of years until the portfolio DOUBLES. Divided into 120, it gives you the number of years it TRIPLES. Both of these are on a compounded basis.
I don’t have a schedule at younger ages, but for RMD at 70 1/2, the distribution requirement is 3.65%, and doesn’t reach 4% until age 73, and 5% at age 79. So, as long as your ROI exceeds your withdrawal rate, your portfolio will continue to increase over the years. If your withdrawal rate exceeds your ROI rate, then you will eat into your principal. You have to decide what ypur cash flow needs, and objectives, are.
2018-08-03 18:23, By: dlzallestaxes, IP: [173.75.247.117]