Updates On Substantially Equal Periodic Payment (SEPP)

Substantially Equal Periodic Payment, or SEPP, is an IRS-regulated method to take distributions from a Traditional IRA without incurring the 10% penalty for early withdrawal. It is calculated based on your life expectancy.  It is typically made over 5 years or until the Substantially Equal Periodic Payment amount equals the balance in your IRA account. This must continue through at least age 59 ½, or until Substantially Equal Periodic Payments have been made for a minimum of five years, whichever is later.  Substantially equal periodic payments cannot be changed for any reason once made. 

Importance of SEPP 

IRA distributions during retirement are not taxable if you meet certain requirements. This allows for tax-free withdrawals, which can be beneficial when planning your income in retirement.  Substantially Equal Periodic Payment is a way to remove funds from IRA accounts while avoiding the 10% early withdrawal penalty normally assessed to non-spouse beneficiaries of the account It ensures that funds are removed from the IRA in a method that is both tax and penalty-free, and it can be calculated into your retirement planning to ensure you meet all of your income needs. 

IRA Rollovers to SEPPs 

Many people transfer their existing IRA accounts when they are no longer working to a self-directed IRA account.  It is generally not possible to make SEPP distributions from an IRA rollover. Substantially Equal Periodic Payments from a Self-Directed IRA account can be made, but usually must meet the 5-year rule. The Substantially Equal Periodic Payment amount cannot be changed under any circumstances.

Three Ways to Calculate SEPP

There are 3 ways to calculate Substantially Equal Periodic Payments using the following:

  1. Substantially Equal Periodic Payments made under a 5-year SEPP can be calculated using either amortization or annuitization.
  2. Substantially Equal Periodic Payments made under an 18-year SEPP can only be calculated using the amortization method.
  3. Substantially Equal Periodic Payments made under a 15-year SEPP can be calculated using the amortization or annuitization method.

The Amortization Method

Under the amortization method for calculating the SEPP plan’s withdrawals,  the Substantially Equal Periodic Payments are calculated by deducting the account owner’s life expectancy factor from the initial value of the IRA. The Substantially Equal Periodic Payment is then divided into annual payments over a designated period of time. The result of this calculation is the SEPP withdrawal for that year, which can be repeated or changed each subsequent year, provided the 5-year period (or 18- or 15-years for certain accounts) is not broken.

The Annuitization Method

Under the annuitization method for Substantially Equal Periodic Payments, an account owner’s Substantially Equal Periodic Payment amount is based on their life expectancy factor. Substantially Equal Periodic Payments must still be made over a designated period of time.  The Substantially Equal Periodic Payment is calculated as an annual payment amount for the duration of the SEPP. If there is more than one beneficiary, this Substantially Equal Periodic Payment can be divided between them based on their life expectancies. 

Amortization or Annuitization

There are many factors to consider when selecting the amortization or annuitization method for Substantially Equal Periodic Payments. The following questions can help you decide which is best for you: 1. Which method would be more beneficial if Substantially Equal Periodic Payments increased over time? Amortization method Substantially Equal Periodic Payments may increase each year, but this is based on the remaining balance at the end of the prior year.  A new life expectancy factor will be used to calculate Substantially Equal Periodic Payments in any subsequent years.  SEPP would only be higher in future years if SEPP in the prior year were less than the SEPP amount needed to at least maintain the initial balance. Amortization is best when Substantially Equal Periodic Payments remain constant, but Substantially Equal Periodic Payments would not continue to increase each year. 2. Which method is more beneficial if Substantially Equal Periodic Payments decrease over time? Annuitization Substantially Equal Periodic Payments may decrease each year, but this is based on the remaining balance at the end of the prior year.  A new life expectancy factor will be used to calculate Substantially Equal Periodic Payments in any subsequent years SEPP would only be lower in future years if SEPP in the prior year were greater than the SEPP amount needed to at least maintain the initial balance. Annuitization is best when Substantially Equal Periodic Payments remain constant, but Substantially Equal Periodic Payments would decrease each year. Whichever method you choose, Substantially Equal Periodic Payments must be made over the designated period of time as Substantially Equal Periodic Payments cannot be changed during that period.  If Substantially Equal Periodic Payments are not made as scheduled over the designated period of time, Substantially Equal Periodic Payments may be recalculated using the life expectancy factor at that time.  Substantially Equal Periodic Payments may even end if SEPP is not made as scheduled over the designated period of time.

When to Use SEPP 

IRA Substantially Equal Periodic Payment is not available for Roth IRAs, only Traditional IRAs. Substantially Equal Periodic Payment is most beneficial when you are in your early 60s, but it can be used for anyone who needs to begin distribution. It is also not available if you continue to work after age 59 1/2 or remain unemployed.

Variables in Substantially Equal Periodic Payments 

When Substantially Equal Periodic Payments are calculated, three variables are used to determine the payment amount for 5 years. These include interest rates, life expectancy, and inflation

Interest Rates

SEPP is determined using interest rates that are in place at the time of distribution. The annuity factor is determined using either the 120th or 360th interest rate. This is the interest rate that would need to be used in order to provide payments equal to your Substantially Equal Periodic Payments. 

Life Expectancy

SEPP is based on IRS-approved life expectancy tables, including National Vital Statistics Table and Uniform Lifetime Table.  Substantially Equal Periodic Payments are based on the life expectancy factor. The life expectancy factor can change if you choose to take Substantially Equal Periodic Payments for a shorter or longer period of time.

Inflation

Substantially Equal Periodic Payment is calculated using inflation as measured by CPI-U at the time of calculation. Substantially Equal Periodic Payment is based on the inflation factor. These variables can be changed for Substantially Equal Periodic Payments that last a longer or shorter period of time to ensure you maintain a steady income level during retirement. Substantially Equal Periodic Payments can also be used as a tool for your IRA distribution planning.

Benefits and Drawbacks of SEPP 

Benefits_and_Drawbacks_of_SEPP_

Benefits

  • Substantially Equal Periodic Payment is exactly what it implies. SEPP provides Substantially Equal Periodic Payments to you for a period of time.
  • SEPP benefits include the ability to obtain steady income during retirement, the ability to meet SEPP requests without penalty, and the ability to easily make SEPP from your IRA.
  • It can also help a Substantially Equal Periodic Payment recipient plan their income over time to avoid running out of money during retirement.

Drawbacks 

  • SEPP recipients are Substantially Equal Periodic Payment receivers for some time. If SEPP starts at age 65, SEPP must be completed by not later than 85 years old. 
  • SEPP must be carefully chosen and monitored to ensure that the chosen period does not end up being longer than you would like it to be. SEPP is not based on your life expectancy or length of retirement.

How to Make Substantially Equal Periodic Payments 

The IRS allows five different methods for making Substantially Equal Periodic Payments. These Substantially Equal Substantial Subscribers Substantially Subscription Subscribers are:

Required Minimum Distribution Method 

This method calculates Substantially Equal Periodic Payments by dividing your IRA account balance by the appropriate divisor factor.

Fixed Amortization Method 

This method amortized your IRA over a certain number of years. It is based on an annuity factor table that uses the account balance and life expectancy to determine Substantially Equal Periodic Payments.

Fixed Annuitization Method 

This method calculates Substantially Equal Periodic Payments based on the IRS-approved mortality table, annuity rates, and your IRA account balance. 

The Sum Subscribed Method 

This is based on a court judgment. It calculates the share amount by dividing your IRA account balance among all beneficiaries equally. 

The Excess Accumulation Subscriber Method 

This method is used by taking the difference between your account balance and an installment amount. You can use the Excess Accumulation Method during a 5-year period. 

Conclusion 

SEPP is a great way to have a steady income flow during retirement and can be used as part of your IRA distribution planning. SEPP may be the right choice for you, but you must understand this concept.

Substantially Equal Periodic Payment is a payment option provided by the IRS. It is an easy and reliable way to plan your IRA distribution and maintain steady income during retirement.
SEPP can be very important for your retirement planning. It helps give retirees income and stability by providing SEPP throughout retirement.
Substantially Equal Periodic Payment is calculated using inflation as measured by CPI-U at the time of calculation.
Interest Rate, Life Expectancy, and Inflation.
SEPP Subscribers must complete all payments within the IRS-mandated time frame.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.