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Ask Our Retirement Expert

Have a question? Ask our Retirement expert.

Have questions? Email Send your question to jbarnash@smartasset.com

What Is a SEPP?

SEPP stands for substantially equal periodic payment. Setting up a series of substantially equal payments is a little-known maneuver that can enable you to withdraw money from your retirement accounts before age 59 1/2 – without paying an early withdrawal penalty. Often an SEPP comes as a result of a lay-off. Want to learn more? You’re in the right place. 

Find out now: How much should I save for retirement

SEPP Basics

Ordinarily, if you’ve been saving for retirement in an account like a traditional IRA, you won’t be able to touch that money before reaching age 59 1/2 unless you’re willing to pay an early withdrawal penalty of 10%. A lot of people don’t have a choice though. A job loss or a medical event leaves them with no alternative but to dip into their retirement funds early and face the penalty.

But what if there were a way to access funds without triggering that 10% penalty? That’s where the SEPP comes in. Though you’ll have to pay the income taxes on the money you withdraw, you can avoid the 10% penalty with an SEPP. It lets you start accessing your retirement funds right away, in a series of annual payments. Your funds can be annuitized, which is a fancy way of saying the money is given out bit by bit, year by year, rather than all at once.

If you want to set up an SEPP program with a retirement fund you have through work (like a 401(k), for example), you’ll have to “separate from service” before the IRS will allow you to annuitize those funds. That’s why the SEPP is a popular option for those who are laid off or decide to stop working in their 50s and want early, penalty-free access to their employer-sponsored retirement plan. But if you want to make an SEPP out of a traditional IRA, you don’t need to stop working to qualify.

Related Article: Average Retirement Savings: Are You Normal?

Who Benefits From the SEPP?

What Is a SEPP?

If you need every penny of your retirement funds to save yourself from bankruptcy, the SEPP isn’t the option for you because you’ll only be able to access a portion of your funds in the first year of the SEPP and in each subsequent year of the program. SEPPs aren’t very flexible. Once you commit to an SEPP you’ll be locked in to a set period, during which time you can’t change your mind and take more money out of your retirement account – unless you want to forfeit the penalty waiver that the SEPP provides.

If you back out of the SEPP before it ends because you decide you want your money in a lump sum, you’ll owe taxes and penalties on any annuitized distributions you took after setting up the SEPP. That’s why the SEPP is best for people who need money to live on, not money to pay off one huge expense like a house that’s in danger of foreclosure or massive uncovered medical expenses.

As we mentioned, SEPPs are often used by people who have been laid off from jobs they had for a long time. It can be an alternative to claiming unemployment benefits or looking for another job. Because it’s tough to find a new job in your 50s, the SEPP is a necessary stop-gap for some people who need income and don’t want to face early withdrawal penalties just because their career hasn’t lasted as long as they hoped it would.

Setting up a SEPP Program

Once you’ve decided that a SEPP is right for you there are three options for you to choose from. To figure out how much money you’ll get during each year of the SEPP program, you can use one of three methods: the required minimum distribution method, the amortization method or the annuitization method. Whichever method you choose, you’ll need to consult a mortality table or life expectancy table to tell you how many more years you can expect to live (morbid, we know).

You then use that life expectancy number, an interest rate and the amount of funds you have to convert to a SEPP to calculate your annual income. According to IRS SEPP rules, “you may use any interest rate that is not more than 120% of the federal mid-term rate published in IRS revenue rulings for either of the two months immediately before distributions begin.” If this sounds complicated, it’s because it is. But you can contact the administrator of your retirement plan and your tax adviser for help setting up a SEPP program.

Once you set it up, you’ll have to use the SEPP for at least five years or until you reach age 59 1/2, whichever time period is longer. Once the longer of those two periods ends, you can change the amount you receive each year or stop the SEPP. It’s important to abide by the rules of the SEPP so you don’t find yourself on the hook for the full early withdrawal penalty just because you failed to take the last required SEPP payment.

Related Article: Jobs for Seniors

Bottom Line

What Is a SEPP?

In a perfect world no one would have to access their retirement funds until they reach a ripe old age. But it’s nice to know that the IRS provides a tax-advantaged, penalty-free option for those who find themselves in a tough spot before age 59 1/2 and have to dip into their retirement funds. It’s not a very well-known option, though, so spread the word.

Photo credit: ©iStock.com/Johnny Greig, ©iStock.com/Christopher Futcher, ©iStock.com/wundervisuals

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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