So your company is looking to downsize or maybe shed some of it's payroll to increase their bottom line. So they start offering "early retirement" packages. For some of you at 59.5 or older it's a great deal and almost a no brainer ...as far as the decision making process goes. Take that money and run!
But many of you are stuck in that 50-54 age range where the thought of retirement can be a little scary. You thought you had several more years to prepare and suddenly you have to make the biggest financial decision of your life in 60-90 days. Talk about an emotional roller coaster. I can't even imagine. Let's look at some options.
The IRS Rule of 55
If you are 55 or turn 55 the year you separate from service you can access your 401K funds penalty free via the IRS Rule of 55. The IRS Rule of 55 allows an employee who is laid off, fired, or who quits a job between the ages of 55 and 59 1/2 to take money from their 401(k) or 403(b) plan without the 10% penalty for early withdrawal. So if you have stash of cash laying there now might be the time to use it to help you bridge that gap until you turn 59.5 and access the lump sum amount you have been offered that hopefully you rolled over to an IRA. That's a viable option for many of you and would be my first choice if I were your adviser. Also a tip if you plan on using that money for retirement you might consider switching it to a "Stable Cash Fund" or "Bond Fund" or something similar within your 401k investment options. That way it's safe from any downturn in the market.
SEPP: Series of Equal Periodic Payments
But let's say you don't have enough in your 401K to bridge that gap or you are in that age of no man's land which would be 50-54. And you will face the 10% early withdrawal penalty if you touch your 401K now. There are several ways we can access your lump sum amount penalty free. The best way would be what is know as IRS Rule 72T or sometimes referred to as SEPP. SEPP, which stands for Substantially Equal Periodic Payments, is a little-known program that can enable you to withdraw money from your IRA or 401(k) before age 59.5 without facing an early withdrawal penalty.
So what we could do is roll your lump sum offer to an IRA (Individual Retirement Account). Then we would set up a SEPP to take money from that IRA penalty free from your age now until you reach 59.5. This would allow us to help you bridge that retirement income gap.
SEPP programs are made possible by section 72 of the Internal Revenue Code, and they serve as one exception to the age requirement for retirement account withdrawals. If you enter into a SEPP program, you’ll start to receive annual payouts from your retirement account for either five years or until you reach age 59.5, whichever comes later. If you want to end these payouts before that point, you’ll have to pay the early withdrawal penalty that you previously avoided. Payouts can be fixed or they can vary from year to year, and they’re calculated in one of three ways. We’ll explore each method in more detail later in this guide.
Setting up a SEPP Program
Once you’ve decided that a SEPP is right for you there are three options for you to choose from. To figure out how much money you’ll get during each year of the SEPP program, you can use one of three methods: the required minimum distribution method, the amortization method or the annuitization method. Whichever method you choose, you’ll need to consult a mortality table or life expectancy table to tell you how many more years you can expect to live.
Use that life expectancy number, an interest rate and the amount of funds you have to convert to a SEPP to calculate your annual income. According to IRS SEPP rules, “you may use any interest rate that is not more than 120% of the federal mid-term rate published in IRS revenue rulings for either of the two months immediately before distributions begin.” If this sounds complicated, it’s because it is. You can ask your tax adviser to help you set this up or at 80/20 Financial Services we can assist you with the process as well.
Once you set it up, you’ll have to use the SEPP for at least five years or until you reach age 59 1/2, whichever time period is longer. Once the longer of those two periods ends, you can change the amount you receive or stop the SEPP. It’s important to abide by the rules of the SEPP. That way, you don’t find yourself on the hook for the full early withdrawal penalty just because you failed to take the last required SEPP payment.
In a perfect world, no one would have to access their retirement funds until they reach a ripe old age. But it’s nice to know that the IRS provides a tax-advantaged, penalty-free option for those who find themselves in a tough spot before age 59 1/2 and have to dip into their retirement funds. Like any other important financial decision, make sure you’ve thoughtfully considered all the potential options and their consequences.
You Need A Plan
A goal of retiring - without a plan to get there - is simply a plan to never retire. Retirement isn't some magical age. It's a dollar amount. If you're age 50 or over and still in the accumulation phase (pre-retirement) we can help you figure out where you need to go and how to get there. If you are retired or nearing retirement, we can create a plan which will outpace inflation and possibly leave a legacy to your family. The consultation is free and without obligation. Contact us to set up a consultation.
For more articles about retirement planning and investing, click here.
Thanks for reading!
80/20 Financial Services is an independent Registered Investment Advisory Firm. We help clients age 50 and over plan their retirement income and investment strategies. Contact us today for help with your retirement needs.