How to Retire Early Without Early Withdrawal Tax Penalties

Early withdrawal penalties may discourage workers from retiring early. But, a substantially equal periodic payment plans (SEPP) allows you to retire early without a tax penalty. Here's how it works.
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Early withdrawal penalties may discourage workers from retiring early. But, investors using a Thrift Savings Plan, 401k or another qualified retirement plan can have their cake and eat it too – so long as it’s in fairly equal slices – according to the Internal Revenue Service. 

IRS rule 72T allows you to avoid the 10% penalty on early withdrawals from your retirement plans, if you follow a Substantially Equal Periodic Payment plan (SEPP).

What is a SEPP? 

SEPPs allow you to receive payments (distributions) for five years after you retire, or until you reach age 59 ½, whichever happens later.

The IRS offers three different methods to calculate the amount, based on your life expectancy tables. 

Three SEPP Calculation Methods

  • The required minimum distribution method is the only plan that recalculates your payment each year, based on your account value and life expectancy. It’s the simplest method but it may result in a lower annual payment. 
  • The fixed amortization method spreads your account value out over a specific number of years equal to your life expectancy. Once you calculate your annual payment it’s set until you terminate the plan, or switch to the RMD method.  
  • The fixed annuitization method is the more complex of the three methods, but you may get the highest annual payment. This method divides your account balance by an annuity factor (from an IRS table based primarily on life expectancy) to determine your annual payment. Once calculated, your annual payment is set until you terminate the plan, or switch to the RMD method. 

Before determining the method you’ll use, you’ll need to know how much additional income you’ll need per year. This would be above and beyond any other sources of income like pensions or employment income. 

Changing Your Thrift Savings Plan SEPP Method

If your financial situation changes during your SEPP plan, the IRS allows you to make a one-time switch to the required minimum distribution method (RMD) from the amortization or annuitization methods. 

If you’ve experienced a major decrease in your account value, it may be a good idea to take advantage of the switch. While payments from the RMD may be lower, they should last longer. This method’s purpose is to make your account last longer than fixed methods. 

If you’re considering changing your method, first consult with a financial professional.  

What to Know About SEPPs

  • SEPPs are a long-term distribution strategy, if you have short-term needs, see if you qualify for a hardship withdrawal or consider a TSP loan.
  • The investment account where your SEPP payments are coming from can’t be from a 401(k) with your current employer. 
  • SEPPs are structured to pay out annually but you choose to receive smaller payments more frequently.
  • You’ll still pay income tax. SEPPs just eliminate the 10% early withdrawal penalty levied by the IRS. 
  • You don’t have to apply your SEPP method to all of your retirement accounts, or even to one entire account. If you only want to use a portion of your Thrift Savings Plan or 401k for early retirement, you can segregate that amount into an IRA and use it for your SEPP funds. Or, you can move all but the amount you want to use for SEPP to an IRA and use SEPP to withdraw the remaining funds from your TSP, 401k or other retirement plan.  
  • SEPPs must generally continue for at least five full years, or if later, until age 59 ½.

SEPP’s can be complex. Before you make the decision to use one, talk to a CPA or CFP to see if this approach is right for you. 

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About Tony Rich

Tony is a 15-year Air Force veteran and an Independent Financial Advisor outside of St. Louis, Missouri. Tony joined the Air Force in 2007 as a Weather Forecaster before transitioning to the Air National Guard in 2011, where he served as a finance officer for five years.

Tony has worked in financial services since 2014. He earned his bachelor's degree in business administration from Webster University and his master's in business administration from Washington University in St. Louis. Tony is married to Elise, who also serves in the Air National Guard. Together they have 5 kids and enjoy spending time outdoors together as a family.

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