A Penalty-Free Route To Tap an IRA
The SEPP strategy lets IRA owners avoid the early-withdrawal penalty by taking equal payments for at least five years or until the owner turns 59½.
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Mike D’Andrea knew something was wrong as soon as the client entered his office in Frederick, Md. The chartered financial accountant had worked with the client for years to make sure he saved enough and invested wisely to realize his dream retirement.
What they couldn’t control was the client being laid off in a corporate downsizing. He told D’Andrea that his severance wasn’t enough to carry him until he was 59½, the age at which he could tap his nest egg without paying the 10% penalty on early withdrawals from tax-deferred retirement savings plans.
To meet his living costs from the day he left his job until he turned 59½, the client opted to transfer a portion of his retirement savings into an IRA and agreed to withdraw all of the cash in substantially equal periodic payments, or SEPPs.

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This strategy—known as SEPP or 72(t) in deference to the section of the tax code that allows it—lets retirement account owners avoid the 10% early-withdrawal penalty by taking equal payments for at least five years or until the owner turns 59½, whichever is longer.
While such payouts appear to be an easy way to access an IRA penalty free, some financial advisers vociferously steer their clients away from the 72(t) option. Amy Pastorino, a wealth management adviser for TIAA in New York City, advises clients to consider 72(t) as “your last possible resort” because “it is very, very rigid and a lot can go wrong.”
To start, you must use one of three methods to calculate the size of the payments. The required minimum distribution (RMD) method is the simplest option—divide the year-end value of assets in your IRA by a lifespan estimate provided by the IRS—but it also typically produces the lowest payment and must be recalculated each year. The other two options—a fixed amortization approach and fixed annuitization method—also look at assets in hand and years to live, but also take into account interest rate forecasts.
The best option for an investor depends on his or her circumstances, so it is prudent to have a professional help you decide. “This is not something you can do yourself,” Pastorino says. “Before you consider 72(t), you should look at other options that are far less restrictive.”
After you start taking 72(t) withdrawals from an IRA, you cannot change the size or frequency of the payout. You cannot make additional withdrawals from the IRA you use for the 72(t) distributions, nor can you deposit money into the account. If you withdraw too much or too little or take a distribution too early, the IRS will levy the 10% penalty tax on everything you have withdrawn up to that point. To avoid mistakes, it’s ideal to set up a separate IRA so you can isolate the money to meet the 72(t) payments from the rest of your retirement assets.
Commit to Stream of Payments
Once 72(t) payments begin, you must receive payouts for five years or until you turn 59½—whichever is longer. For example, if you start taking 72(t) payments at age 50, you must continue to receive those payments until you are 59½, a total of nine and a half years. If you use the 72(t) strategy at age 59, you must take payments for five years, until you are 64—even if you don’t need them anymore. While all the payments will be free from the penalty, you will still owe ordinary income tax on the traditional IRA distributions.
The rigid rules imposed by 72(t) make it clear that the government wants to discourage people from spending their retirement savings before they retire, but lawmakers provided this escape hatch for IRA owners.
Brendan Willmann of Granada Wealth Management, in Asheville, N.C., considers 72(t) as a bridge to get you over a difficult period when you have no other options. “72(t) is attractive because of the no-penalty feature,” Willmann says. “If I’m in a bind, that [feature] sounds pretty good.”
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