How does Betterment handle Substantially Equal Periodic Payments (SEPP)?

What are Substantially Equal Periodic Payments?

Substantially Equal Periodic Payments provide a way to withdraw money from your IRA prior to reaching age 59 ½ without paying the 10% early withdrawal penalty. In order to qualify, certain rules must be followed, including rules relating to the specific amount, frequency and duration of the payments. Although withdrawals will not be subject to the penalty, the recipient will still owe applicable ordinary income taxes (see important details below about tax filing considerations). Making a change to a Substantially Equal Periodic Payment plan may result in a tax penalty.

Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional.

What rules must be followed to qualify as Substantially Equal Periodic Payments?

Payment amounts must be calculated based on the recipient’s life expectancy or the joint life expectancies of the recipient and a designated beneficiary. At least one payment per year must be received, and payments must continue for at least (i) 5 years from the date of the first payment or (ii) until the recipient reaches age 59 ½, whichever is longer.

What are the methods for calculating the equal payments?

There are 3 IRS-approved methods for calculating the payment amount, and each has its benefits and drawbacks. You have the ability to calculate the payment amount yourself using the appropriate life expectancy tables which can be found in IRS Publication 590, Individual Retirement Arrangements (IRAs). Betterment recommends consulting with a tax professional before any calculations are done.

  1. Required Minimum Distribution Method
    1. Typically, this will generate the smallest withdrawal amount
    2. Amount fluctuates each year based off annual recalculation
  2. Fixed Annuitization Method
    1. This will typically have a larger withdrawal amount than the Required Minimum Distribution Method
    2. Amount received is fixed
    3. Calculation is only done once
  3. Fixed Amortization Method
    1. This will typically have a larger withdrawal amount than the Required Minimum Distribution Method
    2. Most complex calculation, but calculated once
    3. Amount received is fixed

Can the calculation method be changed once payments begin?

You can only switch the calculation method once, and only from the fixed annuitization or amortization method to the required minimum distribution method. Also, if you have taken a payment in the current year, you typically will not be allowed to change the method until the following year. Consult a tax advisor prior to making any changes to your SEPP calculation method.

Can the IRA owner withdraw a different amount than the calculated payment amount?

Generally, the only way to change the payment is by switching calculation methods as mentioned above. Any amount withdrawn from the IRA above (or below) the calculated amount will be considered a modification to the SEPP and will subject the entire distribution to the 10% early-withdrawal penalty, not just the excess. Typically, modifying payments in any way, including omitting or stopping payments, will make all current and prior payments subject to the 10% early-withdrawal penalty along with a retroactive interest on the penalty amount for prior year payments.

Can the IRA owner still contribute to the account once the SEPP is in place?

No, once payments have started via the SEPP method, contributions can no longer be made to the IRA. Also, you cannot transfer or rollover assets into the IRA. If you have multiple IRAs, you can still contribute to an IRA account that does not have SEPP payments in place.

If a person has multiple IRAs, do the Substantially Equal Periodic Payments apply to all IRAs or a specific IRA?

SEPPs apply solely to the specific IRA account for which the payments were established, and not any other IRAs held by such person. SEPPs can be calculated on multiple IRAs, but the calculation will be done on the account balances individually. This gives the recipient the ability to move balances between IRAs to get the equal payment number close to desired income.

What are the tax filing considerations?

Betterment will report your IRA distributions to the IRS on Form 1099-R. Importantly, this form will not specify if your distribution qualifies for an exception to the 10% early withdrawal penalty. You will need to claim the exception yourself by filing IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with your tax return. You can find Form 5329 at irs.gov or within your tax preparation software. Consult a tax advisor if you have questions about your tax filing and meeting the requirements of Substantially Equal Periodic Payments.