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Ed Slott's Free IRA Update

April 2009

Volume 2, Number 4

Click here to view previous issues

In This Issue

• Focus on - Substantially Equal Periodic Payments

• Question of the Month

• News, Rulings and Other Updates

• Retirement Planning Tip

• Ed Slott’s IRA Advisor – April Issue




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April Focus: Substantially Equal Periodic Payments


Generally, distributions from retirement accounts are subject to income tax unless the amount represents after-tax contributions. In addition, individuals who are under age 59 ½ when the distribution occurs are subject to an additional 10% tax (early distribution penalty), unless an exception applies. One such exception is the substantially equal periodic payment (SEPP), commonly referred to as 72(t) after the section of the tax code by which it is governed.


General Definition


A SEPP is a series of distributions from a retirement account where the amount withdrawn each year generally remains the same for the duration of the SEPP program. There are three IRS approved methods that can be used to compute SEPP distribution amounts:



Under the amortization and annuitization methods, the account is amortized or annuitized over the individual’s life expectancy and the same amount is usually required to be withdrawn from the account each year for the duration of the SEPP. While the RMD method produces a different distribution amount each year, it satisfies the definition of ‘substantially equal’ providing the calculations are done according to IRS guidelines.


A SEPP can be taken from a traditional, SEP or SIMPLE IRA. It can also be taken from a qualified plan such as a 401(k), 403(b) or 457(b) plan after the individual has separated from service with the employer.


SEPP Duration


A SEPP program must continue for five years, or until the individual reaches age 59 ½, whichever is longer. This means that if someone starts a SEPP at age forty, he will need to continue for at least another nineteen years. Serious consideration must be given to this requirement. An individual should not start a SEPP program if the need for funds is a one-time or short term need. Typically, the ideal SEPP candidate will need the funds for the duration (or most) of the SEPP period.


What Happens if the SEPP is Broken?


The SEPP is considered ‘modified’ if it is terminated before the end of the required payment period, an amount that is more or less than the calculated annual SEPP amount is withdrawn from the account for the year, or if additional assets are added to the account after the SEPP has begun. A modification generally results in the individual being required to pay the 10% early distribution penalty retroactively on all distributions that were taken prior to age 59 ½ under the SEPP program, plus any IRS assessed interest.


When can Payments be Stopped?


Payments can be stopped due to the death or disability of the account owner. They can be modified by changing from the annuitization or amortization methods to the RMD method. If the account balance is not large enough to make the payment due for the year, the account balance can be depleted, thus terminating the SEPP; this can be done regardless of how long the SEPP has been in effect.


Splitting Accounts


Individuals who want their SEPP amounts to be less than what an account produces can split the account so that only the desired amount remains in the account designated for the SEPP. An easy way to do this is to use the amount needed for each year and work backwards to determine the account balance needed to produce the desired amount. This is referred to as a reverse calculation. For instance, if an account produces an annual distribution of $100,000, but the individual needs only $40,000, the reverse calculation can be used to determine the account balance that is needed to produce $40,000 per year. Then an account is established that holds that amount only. A reverse SEPP calculator is available at www.72t.net.


Approach a SEPP with Extreme Caution


A SEPP program seems simple enough on the surface to embolden even the most timid of individuals that they could effectively establish and maintain such a program on their own. But, as is evidenced by the high levels of confusion over the rules and mistakes experienced by individuals posting on the message boards at www.irahelp.com and www.72t.net, taking on a SEPP without expert help is risky business.




Starting a SEPP program requires careful consideration. If the financial need is short term, the individual may want to look to other sources to fill the need or even consider taking the funds from the IRA and paying the early distribution penalty. Individuals should work with a financial or tax professional who is experienced in the area of SEPPs.


For more on SEPPs, visit www.72t.net


Explanations of the rules that govern IRAs are usually provided in Ed Slott’s IRA Advisor Newsletter. If you are not already a subscriber and want to get an idea of the content of the newsletter, you can preview past issues before subscribing.


Set yourself apart from the competition, and bring in millions in new IRA rollover business by subscribing to Ed Slott's IRA Advisor Newsletter and attending Ed Slott's IRA Workshops. Click here to see a schedule of upcoming workshops.

Question of the Month

Question: I inherited three traditional IRAs and would like to combine them into one inherited IRA. Is that permitted?


Answer: It depends. Generally, you are permitted to combine the IRAs if you inherited them from the same person. This is because the total amount that you are required to withdraw under the beneficiary RMD rules would be the same whether the accounts are held separately or combined. However, this is not recommended if the life expectancies used to calculate RMD amounts for the accounts are not the same. This would usually occur if:


  • You are one of the younger of multiple beneficiaries and separate accounts were not established by December 31 of the year following the year in which the IRA owner died.
  • The IRAs are subject to different beneficiary distribution options. This can occur if the IRA owner died before the required beginning date (RBD) and the IRAs are held with different financial institutions where one requires the assets to be distributed under the five year rule while the other allows the distributions to occur under the life expectancy method.


Check the distribution options available under each IRA before combining the balances. Additionally, when moving the accounts, be sure to move them as trustee-to trustee transfers and not as distributions and rollovers, because distributions from inherited IRAs for non-spouse beneficiaries cannot be rolled over.


News, Rulings and Other Updates

Bailey v. Commissioner: Participant owed 10% early distribution penalty because the distribution was from a 401(k) and not an IRA


The participant requested a withdrawal from her 401(k) account. She included the amount in her income, but did not indicate that the amount was subject to the 10% early distribution penalty. She felt that the penalty should be waived under the first time homebuyer exception because the funds were used towards the purchase of her first home. The tax court held that she did owe the penalty, because the distribution was not taken from an IRA. (Reminder: the first time homebuyer exception applies to traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs. It does not apply to qualified plans, 403(b)s and 457 plans).


April’s Retirement Planning Tip:  If You Want No Tax Withheld - Do a Direct Rollover


Taxpayers who make withdrawals from their 401(k) and other qualified plan accounts often instruct the payer to distribute the funds directly to them. However, in such cases the payer is required to withhold 20% for federal taxes which reduces the amount received by the taxpayer. As such, taxpayers who want a specific amount have two options:


  • Increase the distribution amount, so that the net result covers the amount needed. For instance, if the individual wants $100,000, he would request $125,000. ($125,000 – 20% [$25,000] = $100,000.
  • Have the distribution processed as a direct rollover to a traditional IRA., and take the distribution from the IRA. Withholding on distributions from an IRA is at the discretion of the IRA owner, which means the IRA owner can request to have no taxes withheld.


Consideration must be given to the fact that tax may be owed on the distributed amount when the individual files his tax return, and a 10% additional tax will apply to the amount unless he qualifies for an exception. Another important point to note: if the individual is no longer working for the employer that sponsors the qualified plan and he separated from service in the year he reached age 55 or later, the 10% penalty will not apply to distributions that are paid to him from the plan. If the amount is rolled over to the IRA, it no longer qualifies for this age 55 exception.



Highlights from Ed Slott’s IRA Advisor Newsletter - April 2009 Issue


Your April 2009 issue of Ed Slott's IRA Advisor is now available online. 


Every advisor has clients who have had their retirement and other savings decimated by market losses or by fraud losses from culprits like Bernard Madoff and others.


The first question most clients will have is how to benefit from these losses by deducting them and reducing their tax bill.


In addition, IRS has issued new rules on how to deduct these losses on returns being filed right now.


Here's what you need to know to help your clients.





Feature Article

Deducting IRA Losses

6 Tests to Pass

IRA Withdrawal Caution

IRA Loss Deduction Rules

IRA Loss Deduction Examples

Roth Recharacterization Strategy

Claiming vs. Deducting an IRA Loss

IRA Losses Due to Fraud

New Fraud Loss Guidance Issued by IRS



Guest IRA Expert

Robert S. Keebler, CPA, MST, DEP             

Virchow, Krause & Company, LLP                

Green Bay, Wisconsin


Investment Fraud Losses

The Role of the SIPC

Tax Options

Theft Loss - Tax Code Section 165(c)(2)

IRA Fraud Victims

Roth IRA Loss Recovery

Recouping Fraud Losses

Advisor Action Plan

To view current and past issues of the IRA Advisor, click the link below to access our "Subscribers Only" section of our website:
http://irahelp.com/newsletter.php (for America Online users)

If you do not already subscribe to Ed Slott's IRA Advisor Newsletter, you may do so by clicking here and providing the required information, or by calling 800-663-1340. Each issue is 8 full pages of must-have tax information. Individuals who subscribe to the online version of the Ed Slott's IRA Advisor Newsletter, receive access to back issues at no additional cost.

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