Unlocking Early IRA Access: Understanding SEPP (72t)

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Today we are more on the numbers wealthier side. We are talking 72T-SCPP. And quite often you see this referred to as an SCPP withdrawal. What is it? Why are we talking about it? It's what you might use or have to use if you want immediate penalty-free access to funds within a traditional IRA. And you don't hear it referred to as 72T too often. Quite often, it's SEPP. It's Substantially Equal Periodic Payments.

This way of accessing your funds is the least flexible of generally what the other options are. If you think about things like Rule of 55 or Roth conversions or Roth contributions. Getting access to those funds is generally a better option because once it is established, it must be maintained for a minimum of five years or until age 59 and a half, whichever is later. And we'll put up a graphic that kind of gives an example.

If you started in your early 50s, you could see how many number of years you're going to have to go. You don't say you start at 50, you can't go to 55. You have to go to 59 and a half. And if you start at 57, you have to go through 61, stop at 62. Failure to maintain withdrawals or an error executing throughout the years will trigger penalties retroactively for all years since the SEPP was initiated, plus back interest on the retroactive penalties.

And when rates are high, that interest could be high.

The basic concept is this rule turns a retirement account into kind of immediate annuity. And annuity is often a bad word because of the way they're sold and some of the annuity products really aren't the best. In some cases, they certainly are a good fit. An immediate annuity, we often promote single premium immediate annuities where a client will buy an income stream. You can think of Social Security. You're buying an income stream, a future income stream.

And that's a little bit different from an annuity to where it might be an indexed annuity. There could be other. We're not going to get into those now. We talk a lot about them. It's not that most of them are bad. It's just that they're oversold due to the commissions. But in this case, you have your own money. It's within a retirement account because you have a tax preference around it. You were given a tax benefit.

They have rules if you're going to try to withdraw it easy or withdraw it early.

There are three methods which you can determine how much you can withdraw. One is a minimum distribution method, and it varies each year. This is usually the smaller amount. And I will back up and say that with the new rules around SEPPs, you are allowed to do a one-time change from the other two methods, the amortization or annuity methods, the larger method, to this smaller minimum distribution method, one time.

Still awful strict. The reason people like the minimum distribution method, because if they just want to get a smaller amount, it might be nice. But it does vary each year. It puts more onus on you to make sure it's calculated correctly and done correctly. If you do the other two, the amortization or annuity method, and those amounts are usually similar, you can set it up so it's automatic. You calculate it once.

It's a lot tougher to miss given you can even set it up where it's automated to where I'm going to have this amount distributed each year. The issue you have with anything, one of the issues you have with anything like this is how do you invest? If you're taking a large amount out of your IRA, you generally don't want to do it during a down market. Investing in your equities is something that most people should do. It gives you inflation-adjusted return over the long term.

But given we're talking about shorter-term withdrawals from year to year, this is where you kind of have to be careful. So with the amortization annuity method, that amount is known. I would definitely try to get, unless you're really comfortable, get help, pay your CPA an hourly rate or a financial planner that works hourly and have them help you. When you are doing this calculation, you don't have to know everything about it unless you're doing it yourself.

But you're going to need to know the account balance, the reasonable interest rate, and that's changed a little bit in the last few years. You could see a life expectancy table, but most online calculators out there are good and reliable. I would try to verify more than one if you're just going to go with that. As you might guess, when we do this for clients, We have access to some professional grade calculators through financial planning software.

But even if we are using the online calculators out there, we do the math. We actually do the math ourselves just to double check because there's so much at stake. When you think in terms of the account balance, you often need to first determine how much of your traditional IRA you want to subject to the 72T distribution or turn it into an SEP. This is where the smaller amount from the minimum distribution calculation isn't as attractive because in most cases, people can split out their IRAs.

So if you know how much you're going to need, and you could just say you have a million-dollar IRA and you know you have X amount, and I'm just giving you a ballpark number. I'd be given today's rates. This is probably somewhat close, but you could think in terms of if you had a million-dollar IRA, but you only needed about $25,000, $27,000, something like that, you might just take $500,000, make that, subject that to the SCPP distributions, and then leave the other $5,000 alone.

The reason you might do this, too, is that you don't want to avoid the penalties and the retroactive interest that might occur. And keep in mind, you could always SEPP the other IRA, or you could break that up into multiple IRAs. So while the RMD, if you will, method, the minimum distribution method has a lower amount, the question that we run into is, well, why would I use that?

And there could be reasons why, especially given it's calculated each year, maybe if the account value is going down or up. But for the most part, if we're trying to match income streams with, with from year to year, splitting up the IRA and coming up with that firm amount. And then if we need to make adjustments other places, we do it.

As you can tell, doing this is something where it does help to have professional help because there is a lot to go wrong. And again, it's not just based on doing the SEPP calculation. It's saying, why do you need the money? Is it for living expenses? Is it to pay off a loan?

Whatever the case may be. And if it's, you know, if you're when you're talking living expenses, that's where you do need to start doing some financial planning saying, I need X amount, I have this amount, you know, let's SEPP this, what does it look like with the rest we have? What can we take? And so on. Keep in mind that the SEP, once you designate that SEPP account, new funds cannot be added. And any withdrawals have to be part of the SEPP distribution, which makes sense.

And I'm going to say this again just to reinforce the concept. The SEPP or 72T, this process is account-specific. So you can set up an SEPP for one account and then do something different with the other account. Again, it might be a case where you might use it as a backup, but for a number of different reasons, or you just let that grow. And that's actually most often what you see is you SEPP one account, and that's probably maybe a little more conservative investing.

In the other account, you go more aggressive, making sure you have emergency funds. You're coming up with a plan that makes it reasonable that you're not going to have to do any sort of penalty within reason.

When you talk about the reasonable interest rate, there's a couple of ways you can do it. One, the IRS has a new way of where you need to find – you choose one or two rates. It's one 5%, 5%, or 120% of the federal midterm rate determined in accordance of Section 1274D for either of the two months immediately preceding the month in which the distribution began. So you could tell I was reading that. Again, this is where it does help to have professional help.

Someone who, if they're not familiar with these, kind of understands the way these things generally work. So the new rules of the way they apply is essentially sets a floor for the minimum rate that can be used. So currently, the rate, I think, is around 5.2%, 5.15 to 5.3. So quite often, you're going to be using that instead of 5%. I don't like mentioning IRS form numbers very often. But obviously, when you do this, and for our clients, we actually have a form

that we have them fill out. And we have them keep it. We keep a copy in their client vault. So we keep it electronically and in paper just to make sure we know what we did. We know the calculation. We have all those things. An IRS form is Form 5329 that you made an SEP distribution and the funds are excluded from the 10% penalty. Obviously, because this can be costly if you made a mistake or if you just can't justify what you did.

Quite often, you know, folks who, you know, those IRS odds don't come very often, but it's a case of where maybe they just don't have records that they don't remember, which is understandable. You're living your life. So that's where it's making sure you keep detailed records, keep things at least fairly organized. So you can take a look and say, yep, this is what I did. I used the annuitization method based on this value. And this is what we had withdrawn each year. Thank you for joining us.

The key takeaways here are that the SCPP, the 72T, can be a good way to access your funds before retirement, but it is restrictive. The calculations can be tough, and you really do need to make sure you do some of the financial planning around that, looking at what expenses you're going to have, look at other income. What does a tax rate look like? Because keep in mind, we're avoiding the 10% tax rate, but we still could have other taxes because this is ordinary income.

Thank you for joining us. I hope that you can use an SEPP as part of your financial plan if you are trying to access funds before age 59 and a half, because it can be a good thing, although it's tricky. And you really do need to put some plan and some thought into the way you manage it. But if you do those things, it could help you have a healthier, a wealthier, and happy retirement. Don't forget to hit subscribe. Music. Thank you, folks. Thank you.