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Robert Bloink and William H. Byrnes

Retirement Planning > Saving for Retirement > IRAs

This Overlooked Strategy Helps Early Retirees Avoid IRA Withdrawal Penalties 

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What You Need to Know

  • To take advantage of the SEPP exception, the IRA owner can set up a series of equal periodic payments.
  • The exception applies as long as the SEPP remains in place for five years or until the client turns 59½, whichever is longer.
  • The SEPP strategy is for IRA owners only. Clients with only a 401(k) must establish an IRA and roll the 401(k) funds over.

Countless clients left the workplace in the wake of the COVID-19 pandemic. Some left to start a business and gain independence. Others may have simply been fed up and ready to retire early. Unfortunately, those clients who elect to retire young may be subject to significant penalties if they also need to start withdrawing funds from traditional retirement accounts before reaching age 59½.

This “early retirement tax” can quickly put a damper on early retirement. If withdrawals are structured properly, however, the client may be able to take advantage of an often-overlooked exception to the early withdrawal penalty: the substantially equal periodic payment (SEPP) exception.

Early Withdrawal Penalties: The Basics

Most clients know the basic rules. Taxpayers are entitled to contribute a limited amount of pretax dollars to their 401(k)s and IRAs each year, thereby reducing tax liability.

To encourage those people to save the funds until retirement, a 10% early withdrawal penalty applies if the client starts withdrawing funds before reaching age 59½. 

The IRS also recognizes, however, that there are situations where a client might legitimately need to access retirement funds early, so there are exceptions to the rule.

Clients can access retirement funds early and without penalty in the event of (1) death, (2) disability, (3) reaching age 59½, (4) to cover certain unreimbursed medical expenses, (5) purchasing a first home (this exception is limited to IRA withdrawals of $10,000 or less) and (6) a series of substantially equal periodic payments (SEPP).

How Does the SEPP Approach Work?

Assuming the client retires voluntarily (or was involuntarily terminated and elects not to return to work) rather than because of a disability, the SEPP approach may be the only available exception.

To take advantage of the exception, the IRA owner can set up a series of equal periodic payments. The payments can be made monthly, quarterly or even annually to avoid the 10% penalty.

But the exception applies only as long as the SEPP remains in place for the longer of (1) five years or (2) the date the client reaches age 59½.

So, if the client begins the SEPP at age 58, they’ll have to continue the stream of payments until age 63, even though the early withdrawal penalty wouldn’t have applied for the last 3½ years “but for” the SEPP. If the SEPP is ended or modified early, the 10% penalty applies for the entire SEPP term (plus interest). 

The SEPP payment is calculated based on one of three different options: the fixed annuity option, the fixed amortization option or the required minimum distribution option. Each of these options is designed to replicate a drawdown of the account over the owner’s life expectancy. 

The RMD method calculates the SEPP in the same way that traditional RMDs are calculated (based on life expectancy and account value). For younger clients, this typically produces the smallest payments.

The remaining options are based on the client’s life expectancy and an interest rate that has historically been based on the federal midterm rate in effect for either of the two months before the start of the SEPP schedule.

Prior to 2022, the rate could not exceed 120% of that federal midterm rate. Under IRS Notice 2022-06, payment schedules beginning in 2022 and thereafter can use an interest rate that is as high as 5% (or the client can elect to use the old rules, meaning using 120% of the federal midterm rate in effect for either of the prior two months). 

Generally, the rules that apply beginning in 2022 allow clients with newly adopted SEPPs to receive higher payments.

Important Considerations to the SEPP Strategy

The SEPP strategy is available only to IRA owners. So, if the client only has a 401(k) in place, they’ll first have to establish an IRA and roll the 401(k) funds over. 

Even if the client has an IRA, they may wish to establish a second IRA to fund the SEPP. That’s because once the SEPP starts, the client can’t modify the SEPP without triggering the early withdrawal penalty.

Depending on the client’s age and distribution method, they may wish to access additional IRA funds once they reach 59½, and they won’t be able to modify the SEPP to do so.

The client should also carefully consider the distribution method adopted. Once a SEPP starts, the client can make a change from either of the fixed amortization or annuitization approaches to the RMD approach once in the course of the SEPP. The client can’t switch in the other direction, however.

Some clients may wish to take smaller SEPP distributions early in retirement in order to maximize the tax-free growth potential of the IRA for later years. Those clients may be best served by the RMD approach.

Clients who wish to take larger early withdrawals should consider the new IRS rules that can allow for larger payments.


For clients who need to access retirement funds in early retirement, the SEPP strategy can produce significant tax savings. The SEPP, however, will generally be locked into place once it begins — so it’s important to carefully consider the details before jumping in.


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