SEPP Planning Pointers
This list of SEPP Planning Pointers has been curated over the 20+ year lifetime of this website. Carefully consider each pointer before initiating your SEPP plan.
Determine your income needs. Before you start planning your SEPP plan, create a new retirement budget so that you will know how much income you will need during the period covered by the plan. A retirement budget is different than a ‘working’ budget – it does not include commuting costs, business suits, etc., but it will likely include paying for your own health insurance. Factor in the cost of federal, state and local taxes as necessary.
Look at alternative methods to satisfy your income needs. Committing to a plan of withdrawing from your retirement accounts for at least 5 years at a young age is risky. Consider options that may have a shorter duration, a smaller overall impact on your retirement funds, and/or take advantage of other 72t exceptions. Weigh the total cost and risk of these options against a SEPP:
- If you have an employer plan (401k, 403b, etc.) does your plan allow you to begin withdraws earlier (most allow withdraws at age 55)?
- Do you have funds in taxable accounts that you can use until you reach 59 1/2?
- Can you work part-time?
- If you’re younger than 55, can you delay starting your SEPP until age 55 (the shortest time you can take a SEPP).
- Can you take a one-time distribution (with 10% penalty) to hold you until age 59 1/2? Even a few years of 10% penalties may cost less in the long run than 5+ years of withdraws.
- Can you use another 72t exception such as education, medical, or disability? See the list of exceptions here.
Also consider these new exceptions to the 10% penalty courtesy of the Secure 2.0 Act which was signed into law at the end of 2022:
- Federally declared disaster areas (see list https://www.fema.gov/disaster/declarations)
- Terminal illness
- Emergency expenses
- Domestic abuse
- Excess contributions (https://www.irahelp.com/slottreport/secure-20-eliminates-penalty-nia)
Choose the least risky SEPP calculation method – The Amortization Method is the safest method with the largest possible distribution amount. The Required Minimum Distribution method will require annual recalculations which allow room for error, and no ability to make a one-time change to reduce your distributions in an emergency. The Annuitization Method produces a distribution amount similar to, but a little less than the Amortization Method. See the IRS SEPP FAQ page‘s item #6 for explanations of the 3 calculation methods and examples for how to calculate each.
When using the calculators start with Single Life Expectancy Table and the maximum interest rate allowed. If the single life calculations produce a higher payment than you need, break the IRA into multiple accounts using only one of the accounts to produce the desired SEPP payment. You can use these “secondary” IRA accounts for emergency withdraws if needed, or for including another account into your SEPP Universe at a later date.
Don’t Round. When you calculate the annual SEPP amount, don’t round the result – use the exact amount to the penny. The SEPP Distribution Calculator on this website calculates to the penny. Many other online calculators do not. When taking annual withdraws, you must take the calculated annual distribution, no more and no less. A 50 cent variance from your calculated distribution amount is generally thought to be ok, but more than that can subject you to penalties and interest. You can take distributions at any frequency (usually monthly, quarterly, semi-annually, or annually). To determine the amount of monthly distributions, divide your annual distribution by 12.
SEPP Custodial Account. Before beginning any SEPP withdraws, consider using a brokerage Custodial Account that allows you to choose from a wide range of investments (Vanguard, Fidelity, and Schwab are frequently named in the Q&A). Once your SEPP withdraws begin, you can reallocate investments within your custodial account, such as sell stocks to buy other stocks or bonds, etc. And you can move the entire account to a new custodian once your SEPP withdraws begin, but you cannot add money to the accounts. Partial transfers were rejected by the IRS in PLR 200925044 & PLR 200720023.
Plan your distributions and don’t use the first or last day of the month for a distribution date. A distribution on 12/31 leaves no room for errors and no way to correct an error should it occur. Using a distribution date around the 5th or 6th of the month leaves maximum flexibility.
Withdraw SEPP Distribution from a Cash Account. When selling stocks, bonds, ETFs or mutual funds, request for proceeds to be swept into a cash (sweep or Settlement) fund within your retirement account, then make the planned withdrawal from the cash account. By making the withdrawal from your cash account, you will get the exact amount you request, to the penny. You can’t be as exacting when you transfer stock for sale because the stock price changes by the minute.
SEPP Effective Date. The effective date of your SEPP plan is the date the first distribution is made. It is the effective date that determines the maximum interest rate that may be used in the calculations, as well as calculating when your plan will end.
Before you actually begin, know when your plan will end. Your SEPP plan end date is also called your First Modification Date, since it is the first time you can make changes to the amount you withdraw each year (increase, decrease, or stop withdraws completely). The SEPP Plan ends AT THE LATER OF the date you reach age 59 1/2 OR 5 years after your first distribution. Therefore, if you are older than 54 1/2 when you begin your SEPP plan, you will have to continue payments after you turn 59 1/2, up to the 5 year mark. Calculate your end date using our First Modification Date calculator. The 72tNET.com website currently is the only site with a First Modification Date calculator.
Retain all of your documentation for at least seven years after the plan ends. At a minimum, all tax related documentation should be saved for 7 years in case of an IRS audit. With regard to SEPP-related documentation, you should save your initial SEPP calculations, an official statement from a brokerage or other official source with the initial balance used in the calculations, and a statement showing the date and amount of the initial distribution. In addition, you should keep annual statements showing the distribution amounts and timing of all distributions. You may also want to review our sample SEPP Form.
Your SEPP is your responsibility. Don’t assume that someone else is taking care of your plan. Understand how all calculations were performed and verify their accuracy – including calculations provided by a professional! In the fourth quarter of each year confirm that you are on track to receive the required total annual distribution. Take the last distribution of the year by mid-December to ensure the account is settled well ahead of 12/31. The IRS does not allow you to make adjustments to distributions to meet the required annual payment after 12/31.
Mistakes can be costly – Once you begin SEPP distributions, any change in the payment amount, even by accident or mistake by your brokerage firm, is likely subject you to the 10% penalty tax, plus interest. The interest is applied retroactively to all previous distributions. One type of change – changing the frequency of payments within the year (from annual to monthly, for example) is a valid change and will not trigger this penalty. Be careful and document well.
Don’t be part of a SEPP horror story – Establish a plan that will take advantage of insights from past Private Letter Rulings (PLRs) for the highest likelihood of success.
Consult an advisor – mistakes can be very costly. You may be a very good engineer, computer consultant or teacher – but that doesn’t make you an expert on the internal revenue code, investments, and income planning issues.
Have more questions? Please post them in our Discussion Forum.