Life can get expensive. Rising living costs, healthcare expenses, and midlife pivots—such as a career change, early retirement, or supporting a family member—can all leave clients in a situation where they’d like to tap into their retirement accounts early. However, if they are younger than age 59½, withdrawals typically face a 10% penalty tax.
For clients who are seeking penalty-free early withdrawals and are interested in a predictable income stream, a series of substantially equal periodic payments (SEPPs) may be an option worth exploring.
SEPPs Explained
Internal Revenue Code sections 72(q) and 72(t) allow taxpayers to take a series of SEPPs from a retirement account before age 59½ without incurring the standard 10% penalty:
• 72(q) applies to nonqualified annuities (annuities purchased with after-tax dollars outside of an employer-sponsored retirement plan).
• 72(t) applies to qualified retirement accounts (such as employer-sponsored plans or IRAs).
The principal advantage of SEPPs is predictability—a consistent, predetermined income stream over the full commitment period. But that rigidity can also create challenges if circumstances change.
SEPP Rules and Mechanics
When structuring a SEPP plan, compliance is key. Producers should guide clients through the following four requirements:
1. Define the commitment period. The payment period must be the longer of five full years or the time until the account holder reaches age 59½.
2. Set the distribution schedule. Payments must be made at least annually, although more frequent withdrawals are allowed.
3. Choose the calculation method. Clients must select one of the three IRS‑approved formulas for calculating payment amounts (required minimum distribution, fixed amortization, or fixed annuitization).
4. Clarify restrictions. Withdrawals from an employer-sponsored retirement plan are not allowed if the client is still working for that employer. In addition, any unauthorized changes to withdrawals will result in a retroactive 10% penalty (plus interest) on all funds withdrawn over the entire period.
Special Considerations for Roth Accounts
Roth accounts introduce an additional layer of complexity:
• Qualified distributions are already tax and penalty free, so SEPPs offer no added advantage.
• Nonqualified distributions are more challenging, particularly for younger clients. Contributions can always be withdrawn tax free and without penalty, but earnings may be taxable and subject to the 10% early withdrawal penalty if the five-year rule hasn’t been met.
In these scenarios, while a properly structured SEPP can help eliminate the penalty on earnings, the tax liability remains. To avoid unexpected tax consequences, producers should carefully review the sequencing of withdrawals, the age and tenure of the account, and the chosen calculation method.
When It’s the Right Move (and When It’s Not)
A SEPP plan can make sense when a client needs a predictable, steady income for a defined period and no other alternatives are available (such as an exception to the early withdrawal penalty or a low-cost loan). It can be beneficial if the need for immediate liquidity outweighs the potential for long‑term growth.
This approach may not be the right fit if the client values flexibility, if their portfolio can’t support the withdrawals without impacting long‑term objectives, or if there are more tax‑efficient funding sources available. In such cases, maintaining flexibility and preserving growth potential can take priority.
The SEPP, Step-by-Step
Advanced sales producers can support clients who are exploring this option by walking them through the following steps:
1. Identify the account type (qualified vs. nonqualified).
2. Confirm the client’s age and the urgency of their need.
3. Review all penalty‑free exceptions that might apply to the client.
4. If a SEPP is a viable option, help the client choose a calculation method carefully and document thoroughly.
5. Emphasize the commitment length and the risks of mid‑course changes.
A Trusted Guide Through SEPP Strategies and Decisions
When clients follow the rules, 72(q) and 72(t) can provide a dependable income stream before age 59½—but their rigid rules demand careful consideration.
Producers can position SEPPs not simply as an early‑access tool, but as a disciplined income strategy for clients in the right circumstances. The key is guiding clients through the trade‑off between predictability and flexibility, ensuring their portfolio can sustain the withdrawals for the full commitment period. By integrating SEPP strategies into client offerings, producers have yet another way to reinforce their role as a trusted strategic partner in advanced planning decisions.
