Substantially Equal Periodic Payments

We discussed the various exceptions to the early distribution penalties and of those, substantially equal periodic payments (SEPP) needs its own article due to its complexity.  Substantially equal periodic payments allows the participant the opportunity to withdraw funds from an IRA or other qualified retirement plan prior to retirement without the associated taxes or penalties.  SEPP is a longer term solution to financial hardships; individuals in shorter term financial crunches will want to look elsewhere as we will discuss below.

Basic Rules

There are a few basic rules to be aware of when you are thinking about taking substantially equal periodic payments. 

• SEPP programs are not sponsored by the employer and therefore the employee must terminate the employment relationship with the employer before taking distributions. 
   
• There are no age restrictions; and therefore an employee can take these distributions at any age.
   
• Payments must be substantially equal payments and cannot be altered to tailor to your financial needs at any given moment. 
   
• Payments must be calculated in a fashion that equally distributes the total distribution over the joint life expectancy of you and your beneficiary.  The IRS provides life expectancy tables on their website, click here to see them.
   
• There are three methods which you can use to calculated the periodic payments.  They are:  Required minimum distribution, Fixed Amortization, and Fixed Annuitization. 

Calculating Periodic Payments

In order to calculate periodic payments over a lifespan, you need to understand some basic assumptions such as life expectancy, investment returns, and interest rates.  As suggested above, there are three methods that can be used to calculate these payments and each has its own set of rules.  Generally speaking, there are a few common rules that can be said about all three of these methods.

First, the IRS is more likely to flag you if you have computed high monthly payments with your assumptions.  Secondly, lowering your interest rate assumptions will reduce your monthly benefits.  And finally, joint life expectancy tables will reduce the size of your payments as you will now be splitting the money over a longer period of time. 

Conclusion

In conclusion, be careful when setting up a SEPP plan.  Be sure to consult with a financial advisor to ensure you are properly setting this vehicle up.  Again, if your financial needs are shorter term in nature, substantially equal periodic payments is most likely not the appropriate answer for your situation.