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Tapping Your IRA Early? Crack it with SEPPs

(posted: July 26th, 2016)

How to raid your IRA early with fewer or no penalties

Do you need to raid your IRA to pay for unexpected expenses? Generally, the IRS will penalize you for early withdrawals, meaning those taken before age 59 1/2.

Strategy

Arrange to receive substantially equal period payments (SEPPs) from the IRAs. If you handle things right, you won't be penalized, no matter how old you are. But you can't just withdraw funds willy-nilly. SEPPs must meet specific requirements.

Here's the Whole Story

Normally, you must pay a 10% penalty tax if you take withdrawals from an IRA prior to age 59 1/2. The penalty is added on top of the regular federal income tax you owe. But you're exempt from the 10% penalty tax if you arrange to receive a series of SEPPs for at least five years or until you reach age 59 1/2, whichever is later. For example, if you're age 50 now, the payments must continue for at least 9 1/2 years. The IRS bases the payment amounts on your life expectancy (or the joint life expectancy of yourself and a designated beneficiary).

There are three possible methods that may be used for calculating SEPPs. However, if you substantially modify the payment method before age 59 1/2 (or five years, if that's later), the IRS imposes the 10% penalty tax on all the payments.

The Three IRS-Approved Methods Are As Follows:

  • Required minimum distribution (RMD) method: Under this method, you determine the annual payment by dividing the account balance by the number from the applicable life expectancy table for that year. But, those numbers change annually, resulting in a slightly different payment amount each year.
  • Fixed amortization method: With this method, you determine the annual payment by amortizing the account balance over a period of years, using the applicable life expectancy table and assumed interest rate. The annual payment remains the same year to year.
  • Fixed annuitization method: You determine the annual payment by dividing the account balance by an annuity factor derived from a mortality table with an assumed interest rate. As with the second method, the amount stays constant year to year.

The RMD method is the simplest and tends to provide the smallest annual payouts, which is often the objective of IRA holders, while the other two methods generally provide larger payments.

In any event, choose the method that best suits your personal needs. You can rely on us to help you crunch the numbers.

Exceptions

The exception for SEPPs applies separately to each IRA you own. Thus, you might use this strategy for just one or multiple IRAs. Just remember that multiple IRAs will require separate calculations.

A comparable exception to the 10% penalty tax applies to SEPPs paid out from a qualified retirement plan account like a 401(k) account. In this case, you must have "separated from service" to qualify for the exception. You can't still be working for the company.

TIP: Remember that your IRAs and qualified plans are designed for retirement saving. Consider SEPPs as a last resort.

Please Contact Us with any questions.

Images: 123RF

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