IRA Required Minimum Distribution vs. a Substantially Equal Periodic Payment
IRAs are designed to be retirement savings accounts. For traditional IRAs, this means that you will pay a penalty if you withdraw your money too early, and you are required to withdraw your savings at some point during your retirement. One exception to the early withdrawal penalty is to take substantially equal periodic payments. These payments look very similar to the required minimum distribution, but each has its own rules.
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Basic IRA Distribution Rules
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In most cases, you cannot take traditional IRA distributions before age 59 1/2 or you will pay a 10 percent penalty. There are some exceptions to this rule, including disability, first-time home purchase, certain higher education expenses and annuity payments. Once you reach age 59 1/2, you may take distributions as needed for any purpose -- there is no required minimum or maximum, and you don't have to withdraw anything at all. Once you reach age 70 1/2, the rule changes again. You must now take regular distributions -- at least one per year -- and you must take a minimum amount based upon your age and account size.
Substantially Equal Periodic Payments
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If you must tap into your retirement savings before you reach age 59 1/2, you can avoid paying a penalty by taking payments as an annuity, otherwise known as substantially equal periodic payments, or SEPP. You must take at least one payment per year for a minimum of five years or until you reach age 59 1/2, whichever is longer. This means that if you reach age 59 1/2 prior to completing five years of payments, you cannot change or halt the payments until you have fulfilled the five-year term.
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Required Minimum Distributions
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Once you reach age 70 1/2, you must take regular withdrawals from your traditional IRA. These payments are known as your required minimum distribution, or RMD. Each year, you calculate your minimum distribution using your age, account value and life expectancy. You can take more than the minimum, but you cannot take less. You may take payments as often as you need to, but they must occur at least once per year. You take your first payment by April 15 in the year after you turn 70 1/2 and by December 31 each year after that. Note that this means you could take your first and second distributions in the same calendar year.
Calculation
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Both the RMD and SEPPs can be calculated using the same method using your current age and the value of your account on December 31 last year. Use the tables in IRS Publication 590 to find your life expectancy based on your age. Divide your account value by your life expectancy to calculate your distribution. There are two additional methods for calculating a SEPP -- the fixed annuitization method and the fixed amortization method, both described in Revenue Ruling 2002-62. These methods are complicated, and you should get assistance from a professional accountant or financial planner if you would like to use them.
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