Escape the 10% Penalty on IRA Distributions with Substantially Equal Periodic Payments


If you take distributions from your IRA or employer’s retirement plan before the age of 59-1/2, normally you will get tagged with a 10% penalty, in addition to the income taxes owed on the distribution. However, there is a strategy to avoid this penalty by taking “Substantially Equal Periodic Payments”. This strategy allows you to begin making withdrawals before the age of 59-1/2 and avoid the 10% penalty.

There are some rules you must follow to avoid the penalties:

  • The payments must be made at least annually
  • The payments must be calculated using one of three specific IRS methods and are based on the life expectancy of the owner or of the owner and beneficiary.
  • The payments must be made for at least 5 years, or until you turn 59-1/2, whichever is longer

There are some creative ways you can carefully craft the amount of payment you get penalty-free. The rules allow for three different calculation methods to determine the amount of the payment. You can also set up multiple IRAs and calculate the substantially equal periodic payments using only one of the IRAs. This could give you flexibility if the payment based on the entire IRA balances is too large for what you need. The rules also allow for a one time change in method if you start with one of the two calculation methods that allow for this change.

While using Substantially Equal Period Payments is a relatively unknown strategy, it is also complicated and we would advise a consultation to put this strategy into place.

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