Tax rules can help you build retirement savings, but pre-tax accounts come with restrictions. If you retire early and take money out before age 59½, you may owe a 10% early withdrawal penalty on the amount withdrawn.1
In some cases, you may be able to access funds early without that penalty. One option is a substantially equal periodic payment plan.
What Is a Substantially Equal Periodic Payment Plan?
A substantially equal periodic payment plan, or SEPP plan, allows you to withdraw money from pre-tax retirement accounts, such as a traditional 401(k) or IRA, without paying the 10% early withdrawal penalty.1
When you contribute to these accounts, the expectation is that the money will remain there until at least age 59½. However, you may need access to your savings sooner than planned.
Normally, withdrawing pre-tax funds before age 59½ results in:
- A 10% early withdrawal penalty
- Ordinary income taxes on the amount withdrawn1
Exceptions to the 10% Early Withdrawal Penalty
The IRS allows several exceptions, including:
- Death or disability of the account owner
- Qualified higher education expenses
- Medical expenses that exceed certain thresholds
- A SEPP plan
There are other less common exceptions, but SEPP plans are often considered by those retiring early.
Payment Structure and Requirements
With a SEPP plan, you:
- Calculate a specific annual withdrawal amount using an IRS-approved method.
- Take that exact amount each year.
- Do not withdraw more or less than the scheduled amount.
To qualify:
- Payments must continue for at least five years or until you reach age 59½, whichever is later.2
- You must follow the schedule exactly.
If you stop early or take more than allowed:
- The IRS can retroactively apply the 10% penalty to all prior withdrawals.
- You may also owe interest on those penalties.
Allowed Adjustment
You are permitted a one-time switch:
- From the amortization or annuitization method
- To the required minimum distribution method
This may reduce the annual withdrawal amount if you no longer need as much income.
Taxes Still Apply
A SEPP plan helps you avoid the 10% early withdrawal penalty. It does not eliminate income taxes.
Withdrawals from pre-tax retirement accounts are generally taxed as ordinary income. You must report these distributions on your income tax return, whether taken before or after age 59½.
How a SEPP Plan Works
To avoid early withdrawal penalties, your SEPP plan must meet IRS rules under Section 72(t). You begin by choosing a calculation method to determine your payment amount.
Your annual payment is based on:
- Your account balance
- An IRS-approved interest rate
- A life expectancy table provided by the IRS
You can choose from several life expectancy tables:
- Uniform lifetime table
- Single life expectancy table
- Joint life and last survivor expectancy table (if you have a beneficiary, based on their age)
Once calculated, you must withdraw that exact annual amount each year. You may take payments monthly or at another frequency. The total distributed during the year must match your calculated annual amount. Using a retirement income calculator can help.
What Are the Different Types of Calculation Methods?
There are three IRS-approved calculation methods. Each produces a different annual payment.
1. Required Minimum Distribution Method
This method produces the smallest annual payment of the three approved options. Divide your account balance by your remaining life expectancy using an IRS life expectancy table. Recalculate each year based on your updated balance and life expectancy, so the withdrawal amount changes annually.
2. Fixed Amortization
This approach provides the same distribution each year. The payment is calculated to use up your starting balance over your remaining life expectancy, or over you and a joint annuitant's life if applicable. The calculation uses your life expectancy and an IRS-approved interest rate.
Of the three methods, amortization often results in the highest annual withdrawal. However, if your account grows quickly, payments under the required minimum distribution method could eventually exceed amortization payments.
3. Fixed Annuitization
This method also provides equal annual payments. The amount is calculated using an IRS annuity factor and an approved interest rate.
Choosing A Method
The right method depends on:
- Expected growth in your retirement account
- Other income sources
- Whether you prefer higher or lower withdrawals
Review your options carefully with a tax professional before making a decision. Understanding how each method affects your long-term retirement income can help you choose the approach that fits your situation.
Pros & Cons of SEPP Plans
If you are under 59½, a SEPP can let you access money in pre-tax retirement accounts without the usual early withdrawal penalty. This can help if you have saved consistently but do not have enough cash for current expenses. Without the 72(t) exception, you would likely owe additional taxes and penalties.
SEPP Plans Can Be Restrictive
SEPPs come with strict rules. Once you start, you must continue for at least five years or until you reach 59½, whichever is longer.
If you are 50, you must take payments every year until 59½. If you are 57, you must continue beyond 59½ to meet the five-year minimum. You must also withdraw the exact required amount each year, no more and no less.
Once the plan begins, the selected account is locked into the schedule. You cannot make new contributions. If you need extra cash for an emergency, you cannot take additional withdrawals without breaking the plan. Doing so may trigger retroactive taxes and interest.
Rules Can Be Confusing
The timing rules can be difficult to follow. The IRS requires five full years before you can change the plan or take extra money. For example, if you start on November 1, 2026, you cannot take additional distributions until November 1, 2031, even though your fifth payment would occur in 2030.
Because the account becomes restricted, some people separate the amount needed for SEPP payments into a dedicated IRA. For example, if you need $300,000 to generate the required income but have $850,000 in your IRA, keeping the full balance in the plan could create larger withdrawals than necessary. You also would not be able to access the remaining funds without penalties. Moving the unused portion into a separate IRA can provide more flexibility.
Early Withdrawals May Reduce Future Income
Taking retirement funds early can reduce what is available later. Your savings may need to last for decades. Starting withdrawals before 59½ increases the time your portfolio must support you and reduces the potential for long-term growth. While a SEPP may be appropriate in some cases, it requires careful consideration.
Alternative Options Worth Consideration
Before starting a SEPP plan, review the details with a financial professional and consider other options. A more flexible approach may help you access funds without the long-term restrictions of a SEPP plan.
401(k) Access After Age 55
If you leave your job in or after the year you turn age 55, you may be able to take withdrawals from that employer’s 401(k) without an early withdrawal penalty. However, this applies only to the employer plan you just left. For certain public safety workers, the age threshold may be as low as 50.
Use Taxable Savings First
If you are close to age 59½ and need a smaller amount, consider using taxable savings. You might deplete cash reserves with that approach, but you could offset that effect by increasing cash in your traditional IRA. Then, if it turns out that you need additional money, you can reevaluate a SEPP (or other ways of getting that cash). You might even qualify for a different exception at that point depending on the circumstances.
Review Other Potential Solutions
Other strategies may also be available. A financial professional or tax advisor can help you review ways to meet IRS rules while generating the cash flow you need.
Bottom Line
A SEPP plan can give you access to money in pre-tax retirement accounts, which can be helpful if you retire before age 59½ or need funds earlier. You avoid early withdrawal penalties, but you will still owe income tax on most withdrawals.
These plans are not very flexible, though you do have some control. It is a long-term commitment, and changing the plan can lead to significant penalties. Review the strategy carefully with a financial professional and compare it with other funding options before moving forward.
Sources
- Retirement topics - Exceptions to tax on early distributions. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions.
- Substantially equal periodic payments. https://www.irs.gov/retirement-plans/substantially-equal-periodic-payments.
