As we finally enter summer, COVID has slowly begun to recede as diagnosed cases decrease and vaccination rates increase. For many of us, we’re experiencing a return to “normal”, thankfully. Most of us were affected in one way or another by the pandemic over these past 2 years, whether it was physically, emotionally, financially – or a combination of these. Many faced financial challenges for a variety of reasons, including job loss, a reduction in hours, or the strain of supporting family members who needed financial assistance. Congress responded by passing the Coronavirus Aid, Relief, and Economic Security Act or “CARES” Act, in March of 2020 to offer some aid to those struggling. It was a $2 trillion stimulus bill designed to blunt the impact of an economic downturn set in motion by the global coronavirus pandemic.
One important benefit was the ability to withdraw funds from your retirement plan without penalty. For example, if you had money in an IRA or 401(k) and wanted to take funds out to help get you through COVID challenges, you could withdraw up to $100,000 without incurring the normal 10% penalty and could spread out the taxes due over 3 years instead of having to pay them all at once. This was a great benefit for those who suffered a financial need due to COVID and had available retirement funds.
While this was a real plus, it wasn’t permanent. You see, the CARES Act no longer applies to these withdrawals so you can no longer take funds out of your retirement plan before age 59-1/2 without incurring a 10% penalty, on top of any taxes you’ll owe. I had this very conversation recently with, I will call her, “Joan”, in my office a week back or so. Joan was an HR director at a small company until recently when she had to retire due to health problems. She is just fifty-four and planned to work until age sixty. She is worried about how to make ends meet before Social Security kicks in. Joan has for decades in her company 401(k) plan and also has a sizeable IRA, but she was counting on not needing that money just yet. Because she is no longer earning a paycheck, she may have to tap into some of her retirement funds now – but the thought of losing 10% of her money to the IRS just amplified her worries.
Hmmm . . . there was a silver lining.
I explained to Joan that while she still need to dip into her retirement savings, she has options. I rolled out to her a strategy called SEPP, which stands for “Substantially Equal Periodic Payments”. I find that this strategy isn’t necessarily commonly understood by a lot of folks, but it’s a viable option if you find yourself in a pinch and need to access your retirement funds early.
So, let’s dig in. With SEPP, the Internal Revenue Service permits you to convert your qualified retirement plan assets into an income-like stream while avoiding the 10% premature withdrawal penalty. Basically, you are allowed to take income from a qualified plan such as an IRA or 401(k) before age 59-1/2 as long as you take those payments for five years or until you reach age 59-1/2, whichever comes later. And this part is important, folks – once you begin taking payments under a SEPP, you will want to finish the income plan. You can’t decide after a few payments that you no longer want to take income from your retirement assets. If you do, you’ll be subject to the same 10% penalty you would have paid the IRS had you taken regular early withdrawals. The penalty will apply to all of the previous SEPP distributions you received up until that point.
Now, this option isn’t right for everyone and there are a few caveats. For example, establishing a SEPP means you can no longer contribute to the retirement plan from which you’re withdrawing funds. Not only will you no longer be saving for retirement, but you’ll also forgo any future earnings the money that’s withdrawn might have earned. If you’re someone much younger and don’t plan to retire for decades, you’ll still be stuck taking these withdrawals long after you may need them. But for Joan, this might make more sense since she doesn’t plan to work again. She can use the SEPP to help bridge the gap between now and age 59-1/2, when she can make regular withdrawals without any IRS penalty.
And for Joan, there’s even better news – the IRS recently updated the rules governing SEPPs, allowing her to withdraw even more money. In January, the IRS issued its Notice 2022-6, which updated how SEPP distributions are calculated. Previously, the interest rate used in SEPP calculations could not exceed 120% of what’s called the federal mid-term rate. However, the IRS now allows you to use a 5% interest rate or 120% of the federal mid-term rate, whichever is higher. This will affect those who use either the amortization or annuitization method for calculating their SEPP distributions.
The mechanics of how the income is calculated gets complicated so you’ll want to work with a retirement specialist if you’re interested in taking advantage of this strategy. But the bottom line is that this new guidance might mean a significantly higher amount of money for you at a time that you need it.
The SEPP is just one of a number of options you might have if you’re in a pinch, and there’s no one solution that will work best for everyone. But if it makes sense for you, consider enlisting help to make sure you can take advantage of these increased calculations and avoid tripping on any IRS landmines.
And as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS offers investment advisory services through Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield.
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