A Tale of Two IRAs: Using a Series of Substantially Equal Periodic Payments to Fund an Early Retirement

By Wayne Firebaugh
Member of Ed Slott’s Elite IRA Advisor Group^SM

Multiple studies suggest that we often end up retiring earlier than initially anticipated or hoped. One study by JPMorgan Asset Management found that although two-thirds of current workers plan to continue working until age 65, fewer than one in four actually manage to do so. Although the reasons vary, premature retirement poses a two-fold portfolio stress – a shorter accumulation time and a longer withdrawal period. It also presents a potential tax complication when you’ve not reached 59 ½ – that magic age at which you can withdraw retirement money without an additional 10% premature distribution penalty.

Recently, my clients, Roger and Kathy, found themselves in just such a situation when Roger’s job was eliminated in a corporate restructuring. With little chance of finding a comparable job at age 54, Roger started a handyman business. Although he had plenty of work, Roger could never earn quite enough to cover the family’s budget.

Although their diligent efforts had allowed them to accumulate a nice IRA portfolio, Roger and Kathy felt that adding the 10% penalty on top of state and federal income taxes simply made IRA withdrawals too expensive except in an extreme emergency. Fortunately, the tax code contains an option for obtaining immediate income from a retirement plan while also allowing the account owner to avoid the 10% penalty. The solution for Roger, Kathy, and many other accidental retirees is what Internal Revenue Code section 72(t) calls a Series of Substantially Equal Periodic Payments (SSEPP). 

Think of an SSEPP as an early “pension” that you build using your other retirement accounts. The tax regulations give you three options for calculating the amount of that pension with each option considering both your account size and age at the date you begin the SSEPP. From there, the calculations become a little complex without a specialized SSEPP calculator. However, such calculators are available from many mutual fund family websites or through advisors who specialize in retirement income planning.

There is a downside to implementing an SSEPP. IRS rules require that, once started, you must take your SSEPP for the greater of five years or until you turn 59 ½. If you stop your payments prematurely or otherwise modify your IRA through additional contributions or withdrawals, you break the SSEPP. When this happens, you must pay all the 10% premature distribution penalty you had previously avoided plus interest on those foregone penalties. Since Roger began his SSEPP at age 56, this means he committed to take payments until at least age 61 – the greater of five years or 59 ½ – from the date he started the payment stream.

However, there is also a solution to SSEPP inflexibility. Divide the retirement account into two separate retirement accounts. This works because the rule prohibiting a “modification” applies only to the specific account which is distributing the SSEPP payments. Your other retirement accounts remain unrestricted. For Roger, this meant dividing his approximately $450,000 IRA into two smaller IRAs – one to serve as the source of his SSEPP payments and the other to provide future flexibility and liquidity.

To use an SSEPP to provide the additional income needed during your premature retirement, follow these steps:

1. Determine how much additional income you need (SSEPPs are calculated based on an annual total, but you can take monthly payments).
2. Use an online calculator or consult an advisor who specializes in retirement income planning and IRAs to determine how large the SSEPP retirement account must be.
3. Transfer at least that amount into a new retirement account. Note that even though the tax code allows you to establish a SSEPP in a 401(k), IRAs provide more flexibility and you cannot usually have two 401(k) accounts at the same employer.
4. Don’t touch anything! You can safely adjust your investment mix, but do not otherwise modify the SSEPP payment account until the later of five years or you reach age     59 ½. 

It is true that you may not be able to control the timing of your retirement. That doesn’t mean you lack control over the timing of your retirement income.

Wayne Firebaugh is a CPA, CERTIFIED FINANCIAL PLANNER^TM Practitioner, and Accredited Investment Fiduciary® who owns a Virginia-based financial planning and investment management practice. Since Wayne believes that financial advice should be offered in the client’s best interest, he gladly operates under a fiduciary standard. As a member of Ed Slott’s Elite IRA Advisor Group, Wayne concentrates his efforts on counselling clients with respect to retirement income planning. From his daily radio show, Firebaugh on Finance, Wayne provides thoughtful advice on a range of financial topics affecting his listeners’ retirement security. You can reach me at http://www.waynefirebaugh.com/.