But if you need to access your retirement funds a little early, there’s a way to do it without incurring the penalty—but it does come with some potential downsides.
A SEPP involves setting up annual distributions from a qualifying retirement account (like an IRA or a 401(k)—although you can’t use a 401(k) at a current employer) over a period of five years, or until the account holder turns 59½. That’s where the “substantially equal” part comes in—a SEPP isn’t a one-time distribution, it’s a schedule of more or less equal distributions over a period of time.
The Required Minimum Distribution (RMD) Method, which calculates the annual payment by dividing the account balance by your life expectancy based on the IRS’s tables; the annual payment is recalculated each year and can change from year to year.
The Fixed Annuitization Method, which calculates the payment by dividing the account balance by an annuity factor based on a chosen interest rate and your life expectancy; the annual payment amount stays the same each year.
SEPP downsides
If a SEPP seems like a magical way to tap that nest egg without penalties, Daya cautions that there are some downsides.
Another consideration is taxes, which you will have to pay on the distributions like you would on any income. And SEPPs aren’t easy to figure out, even if you handle a lot of your own finances and do your own taxes. “Calculating the SEPP payment amount is very complex,” Daya says. “You should consider working with a financial professional to help you meet all of the IRS’s compliance rules.”
The SEPP option
Setting up a SEPP can be a good idea if you are retiring early and need access to your funds for your living expenses. If you have no other income or the income you do have is insufficient, a SEPP can bridge the gap between today and official retirement. And if you need regular income over a long period of time due to an unexpected financial challenge, a SEPP might be a good way to provide that.
“They are not for short-term emergency expenses,” Daya says. “A SEPP is a way to provide a consistent income stream over five or more years. Everyone’s financial situation is different, and whether a SEPP makes sense for you will depend on a number of personal factors.”
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