A SEPP, sometimes called a 72(t) plan, is one of the few ways to access an IRA early without the 10 percent additional tax and without a specific qualifying expense. People who retire in their early 50s use it to bridge to 59 and a half.
It works well. Until something changes. Then a single extra withdrawal can trigger a tax bill covering years of payments.
The exception
IRC 72(t)(2)(A)(iv) exempts distributions that are part of a series of substantially equal periodic payments, made at least annually, for your life or life expectancy, or the joint lives or life expectancies of you and your designated beneficiary. Payments from an employer plan qualify only after you separate from service with that employer.
The IRS's current guidance on how to compute those payments is Notice 2022-6, which replaced earlier guidance. It recognizes three methods.
The three methods
| Method | How the payment is set | Payment changes? |
|---|---|---|
| Required minimum distribution method | Account balance divided by a life expectancy factor each year | Recomputed annually; varies with the balance |
| Fixed amortization method | Balance amortized over life expectancy at a chosen interest rate | Fixed annual amount |
| Fixed annuitization method | Balance divided by an annuity factor using IRS mortality tables and a chosen rate | Fixed annual amount |
Under Notice 2022-6, the interest rate for the fixed methods can be any rate up to the greater of 5 percent or 120 percent of the federal mid-term rate for either of the two months before the first distribution. The notice also allows a one-time switch from either fixed method to the RMD method without that switch being a modification. The life expectancy tables are those in Treas. Reg. 1.401(a)(9)-9.
How long you are locked in
Once you start, payments must continue unchanged until the later of five years after the first payment or the date you reach 59 and a half. Section 72(t)(4) sets that window. Start at 52 and you are locked in until 59 and a half. Start at 57 and you are locked in until 62.
The five-year period is measured from the date of the first payment, not from the first calendar year. People who start a SEPP in the fall and stop five years later in January have broken it by months.
What happens when you modify it
If the series is modified during the lock-in period, other than by reason of death or disability, section 72(t)(4)(A) increases your tax for the year of the modification by the 10 percent additional tax that would have applied to every prior payment, plus interest for the deferral period. The IRS calls it recapture. Everyone else calls it a busted SEPP.
Say a 54-year-old started a SEPP three years ago at $30,000 a year, then took an extra $15,000 for a roof. The extra withdrawal is a modification. The recapture covers the 10 percent on all $90,000 of prior payments, $9,000, plus interest, plus the 10 percent on the extra withdrawal itself. A $15,000 roof becomes a five-figure tax problem. The figures are illustrations, but the mechanism is exactly how the statute works.
Common ways retirees bust a SEPP
- Taking an extra withdrawal from the SEPP account, even a small one.
- Skipping or shorting a payment, including miscalculating the RMD-method amount.
- Adding money to the SEPP IRA, through contributions or rollovers in.
- Transferring part of the SEPP IRA to another account in a way that changes the account balance used for the series.
- Changing methods other than the one-time switch to the RMD method.
- Stopping early, because you got a job or no longer need the money.
Keep the SEPP IRA separate from everything else. If you need flexibility, set up the SEPP on only part of your IRA money by splitting accounts before the first payment, and leave other IRAs out of it.
Keep a SEPP file
Recapture disputes are documentation disputes. If the IRS questions a SEPP years later, you will need the account balance used, the date it was measured, the method, the interest rate and the month it came from, the life expectancy table, and proof that each annual payment matched. Custodians change and records get purged. Keep your own file for the entire life of the series and for several years after it ends.
Exceptions to recapture
The statute excludes modifications by reason of death or disability. SECURE 2.0 also addressed some technical situations, including certain rollovers and annuity arrangements, in 72(t)(4)(C) and the related provisions. If an account change seems unavoidable, for example because a custodian is closing, get advice before the money moves.
A Notice 2022-6 rule also protects you if the account runs out. If the balance is exhausted because of investment losses, the cessation of payments is not treated as a modification. That rule is narrow; it covers running out, not choosing to stop.
Reporting
SEPP payments are typically reported on Form 1099-R with code 2 if the payer knows the series qualifies, or code 1 if it does not. If you receive code 1, claim the exception on Form 5329 with the SEPP exception number from the instructions. In the year of a modification, the recapture amount is reported on Form 5329 as well, following the instructions for that year. See Form 1099-R distribution codes for how mismatches create notices.
If you already busted it
Do not compound the problem. Report the recapture correctly in the year of the modification, because underreporting it adds accuracy-related penalty risk. Compute the interest as required. If the resulting balance is more than you can pay, set up a payment plan before notices escalate. A busted SEPP is a tax bill, not a crime. It is resolved like any other balance. See installment agreements in Pinellas County.
Life changes during the lock-in period
Five years is a long time in retirement planning, and the lock-in can run longer. Divorce, a spouse's death, a new job, a health crisis, or a market drop can each make the original plan look wrong. The rules do not bend for those events, except death and disability. Before you react to a life change by changing the SEPP account, look for money elsewhere: a non-SEPP IRA, a taxable account, a home equity line, or another 72(t) exception that applies to a different account. Stopping a SEPP early is almost always the most expensive choice on the list.
A divorce deserves special mention. Splitting a SEPP IRA under a divorce decree raises modification questions that depend on the details. Get advice before the decree is entered, not after.
Before you start a SEPP
- Confirm you cannot use a simpler exception, such as the rule of 55 for an employer plan. See the rule of 55.
- Decide how much income you truly need through the end of the lock-in period.
- Split IRAs so only the needed amount is committed.
- Document the method, rate, balance, and table used, and keep that file for the life of the series.
- Calendar the exact end date of the lock-in period.
Next step
If you are running a SEPP and something in your life is changing, call before you touch the account. If the recapture has already happened and created a balance you cannot pay, call (813) 229-7100. The firm's guide on setting up an IRS payment plan explains the first step.
Questions people ask
How long do I have to keep SEPP payments going?
Until the later of five years from the first payment or the date you reach 59 and a half, under IRC 72(t)(4).
What happens if I take an extra withdrawal from my SEPP IRA?
It is a modification. Under IRC 72(t)(4)(A), you owe the 10 percent additional tax on all prior SEPP payments, plus interest, in the year of the modification.
Can I change my SEPP calculation method?
Notice 2022-6 permits a one-time switch from the fixed amortization or fixed annuitization method to the required minimum distribution method without it being a modification. Other changes generally bust the series.
Is it a modification if my account runs out of money?
Under Notice 2022-6, if the account is exhausted because of investment results, the end of payments is not treated as a modification.
General information, not legal advice. Reading this page does not create an attorney-client relationship. Tax rules and dollar thresholds change; confirm the current figures for your tax year before acting.