What You Need to Know
- Taxpayers can structure a series of substantially equal periodic payments to gain access to their retirement funds without penalty.
- New IRS guidance gives account holders the opportunity to receive a larger periodic payment.
- Clients shouldn't be encouraged to tap retirement savings early, but SOSEPPs are an option for those facing an unexpected cash shortfall.
As most clients know, distributions from traditional individual retirement accounts are subject to harsh penalties on top of ordinary income taxes if the account owner takes a distribution before reaching age 59½. While several exceptions to the IRA early withdrawal penalty exist, most of those exceptions aren’t particularly helpful for clients who merely need access to their funds because of an unexpected cash shortfall.
On the other hand, one exception is available to all IRA owners, regardless of their circumstances and regardless of the purpose for the distribution. Taxpayers can structure a series of substantially equal periodic payments (SOSEPP) to gain access to their retirement funds without penalty — and for any reason. For many clients, new IRS rules may have just made the SOSEPP option significantly more attractive.
SOEPPs: The Basics
SOSEPPs are exempt from the 10% early distribution penalty that applies to traditional retirement account distributions prior to age 59½. The IRA owner can set up a series of equal periodic payments (whether the payments are made monthly, quarterly or even annually) and avoid the 10% penalty as long as the SOSEPP remains in place for the longer of (1) five years or (2) the date the recipient reaches age 59½. If the SOSEPP is ended or modified prior to that time, the 10% penalty applies (plus interest).
The SOSEPP payment is calculated based on one of three options (the fixed annuity option, the fixed amortization option or the required minimum distribution option) that mimic a drawdown of the account over the owner’s life expectancy. The most commonly used options are based on the client’s life expectancy and an interest rate that’s historically been based on the federal midterm rate in effect for either of the two months prior to the start of the SOSEPP schedule (the rate could not exceed 120% of that federal midterm rate).
Beyond those rules, clients can structure their payments using a single life expectancy or joint life expectancies of the IRA owner and designated beneficiaries.
IRS Notice 2022-06
In recent years, the required interest rate for calculating SOSEPP amounts has been extremely low. In other words, the client’s payments were typically much lower than needed because of the low interest rate assumptions that were in place, so that the SOSEPP payment method wasn’t useful for many clients.