IRA Substantially Equal Periodic Payments

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in California is representative of a common question on IRA distributions.

"I have a client who is under the age of 59½ and wants to take some withdrawals from their IRA. I understand that there is an exception to the additional 10% early withdrawal tax for a series of substantially equal periodic payments. How does that exception work?"

Highlights of the discussion

Indeed, one exception to the 10% additional tax on early withdrawals from an IRA under IRC §72(t) is for a series of substantially equal periodic payments (SEPPs). However, the series of payments must meet several stringent requirements to qualify for this exception.

The payments must be calculated based on the IRA owner’s life expectancy using one of three safe harbor methods outlined in IRS Notice 2022-6 and must be made at least annually. The three approved methods are:

• Required Minimum Distribution (RMD) method,

• Fixed amortization method, or

• Fixed annuitization method.

Under Notice 2022-6, there is a one-time permitted switch from either the fixed amortization or fixed annuitization method to the RMD method without triggering modification. In addition, the following requirements apply:

• Contributions or transfers to the IRA could affect the SEPP stream and constitute a “modification” of the SEPP arrangement. A best practice is to isolate the IRA from which the SEPP series applies, and avoid any additions, rollovers, transfers, or commingling.

• The IRA owner cannot take any additional distributions from the IRA during the period (at least five years) of the SEPPs. (Note that at least one Tax Court has suggested that an additional distribution that qualifies for another IRC §72(t) exception to the 10% additional tax would be permissible [see Benz v. Commissioner, 132 T.C. 330 (2009)]. However, this remains an unsettled area. Conservatively, one should avoid any extra distributions from the SEPP IRA.

• The series of SEPPs must continue without interruption until the later of the:

  • Fifth anniversary of the first SEPP payment, or

  • Date on which the IRA owner attains age 59½. For example, an individual who is age 50 when the SEPPs begin would be required to continue the payments until age 59½.

If any of these requirements are not met, or if the series of SEPPs is modified in some other fashion, then all previous payments made in the series will become subject to the 10% additional tax, along with accrued interest. However, a change in the series of SEPPs that is due to the death or disability of the IRA owner is not considered a modification that triggers the recapture tax.

Conclusion

One exception to the 10% additional tax on early withdrawals from an IRA under IRC §72(t) is for a series of SEPPs. Many rules apply so a guidance from a tax professional is encouraged. For more information, visit the IRS website for a series of FAQs on SEPPs.