Rule 72(t) and SEPP Distributions

How it works

Section 72(t)(1) adds a 10% additional tax, on top of ordinary income tax, on the portion of a distribution from a "qualified retirement plan" that is includible in gross income. Section 4974(c) defines that universe broadly: a section 401(a) plan or trust (including a 401(k)), a section 403(a) annuity plan, a section 403(b) tax-sheltered annuity, and a traditional IRA under section 408(a) or 408(b). Section 408A extends the same treatment to a Roth IRA except as it separately provides, so the 10% tax and every exception to it, SEPP included, reaches traditional IRAs, Roth IRAs, and employer plans alike.

One of those exceptions, in section 72(t)(2)(A)(iv), excuses "distributions which are part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary," the entire statute behind a SEPP program. Its calculation methods, interest-rate ceiling, mortality tables, and modification rule all come from sub-regulatory guidance filling in what "substantially equal" means.

The guidance in force today is IRS Notice 2022-6, not the guidance that controlled this calculation for the prior two decades. It governs any series starting on or after January 1, 2023, and a series that began in 2022 could use it early. Two things changed, both moving the payment amount: the interest-rate ceiling picked up a 5% floor it never had, and the life-expectancy and mortality tables were swapped for the newer set adopted in the 2020 required minimum distribution regulations, producing a smaller payment than the old tables would have for the same balance and age.

Three ways to size the payment

Notice 2022-6 keeps the three methods that have always defined this area.

• Required minimum distribution (RMD) method. The payment equals the account balance divided by a life-expectancy divisor, both redetermined every year, the smallest and most variable of the three; recalculating it annually is not a modification.
• Fixed amortization method. The balance is amortized as a level payment over the first year's life-expectancy divisor, at an interest rate chosen once. The dollar amount then repeats every year.
• Fixed annuitization method. The balance is divided by an annuity factor built from the mortality rates in the retirement regulations and a chosen interest rate. Also level, also set once.

The rate for either fixed method cannot exceed the greater of 5% or 120% of a published federal mid-term rate for one of the two months before the first payment; Pub. 575 and Pub. 590-B both flag that the fixed methods "may require professional assistance."

An IRA can be split before this begins

The account balance that feeds all three methods is defined per account, not per taxpayer, unlike section 408(d)(2)'s pro-rata rule for a backdoor Roth conversion. The IRS's own FAQ confirms a SEPP series is determined for one account, and a taxpayer with more than one may run an independent series from each, splitting off a smaller IRA to size the program down. The FAQ is informal confirmation of a definition Notice 2022-6 already supplies.

What this is worth in Florida

Nothing changes here for a Florida resident. Florida has no individual income tax, so there was never a state layer on either side of this: no withholding question and no estimated-tax question to coordinate. Every dollar of consequence from getting a SEPP program right, or wrong, is federal.

Who this applies to

SEPP is the most demanding exception inside section 72(t)(2), worth building only after every simpler one is ruled out; several need no formula, no multi-year commitment, and no risk of a modification penalty. The table below is not the complete list, section 72(t)(2) runs from (A) through (N), but it shows why an IRA and an employer plan are not interchangeable here.

The most consequential row, for a client between 55 and 59½, is separation from service: section 72(t)(3)(A) excludes an IRA from it by name, so it only ever shelters plan money, and rolling that balance into an IRA before checking this destroys the exception permanently. Anyone in that age band about to roll a 401(k) into an IRA needs that conversation first.

That leaves SEPP for a narrower group: someone under 55 with money trapped in a plan or IRA, an IRA owner of any age under 59½ since the age-55 exception never reaches an IRA, or anyone whose bridge-income need exceeds what a capped exception can cover.

A SEPP built on plan money carries one more gate an IRA does not: section 72(t)(3)(B) bars payments until the participant separates from service, a gate an IRA has no equivalent of, which is why SEPP runs far more often on an IRA than inside a plan. The same timing governs an owner's own solo 401(k), one more difference worth weighing alongside the comparison in my SEP-IRA versus solo 401(k) guide.

A Roth IRA changes the order of the questions

SEPP works on a Roth IRA, but the distribution-ordering rules in section 408A often make it beside the point at first. A distribution comes from contributions first, always free of income tax and the 10% tax, then from conversions first-in, first-out, then from earnings. A program sized within the taxpayer's contribution basis distributes nothing but basis, creating no income, so the 10% question never arises until distributions reach the conversion or earnings layer. A separate five-year rule treats a distribution allocated to a conversion made within the preceding five years as includible in gross income for section 72(t) purposes even though it was already taxed, so SEPP still has work to do there. That rule is independent of the different five-year rule deciding whether Roth earnings come out tax-free at all; SEPP only ever answers the 10% question.

What it requires

Several conditions have to be true together before a SEPP program is the right tool, and a few more have to stay true for as long as it runs.

• Under 59½ when it starts. Once the taxpayer turns 59½, the ordinary age exception applies on its own and SEPP is no longer needed.
• Every cheaper exception ruled out first, in writing. Given the commitment below, this is not optional diligence.
• Separation from service already happened, for a qualified plan. Section 72(t)(3)(B) applies this gate to a plan or annuity contract, never to an IRA.
• A commitment to the later of two dates. Section 72(t)(4)(A) requires unmodified annual payments through the later of five years from the first payment or the date the taxpayer turns 59½, which for someone starting well before 55 runs well past five years.
• A valuation date and a method chosen up front. Notice 2022-6 allows any date from the prior December 31 through the first distribution for either fixed method; the RMD method instead uses that year's own balance under the ordinary RMD rules.
• No additions and no transfers while the program runs. Adding money beyond ordinary investment growth, or moving any part of the account elsewhere, is a modification under Notice 2022-6, with one narrow exception: section 72(t)(4)(C) permits a rollover to another qualified retirement plan if the combined payments from both accounts would still satisfy the SEPP test.
• Only one kind of mid-course correction is allowed. A taxpayer may switch, once, in any later year, from either fixed method to the RMD method, with no penalty for the switch itself, only in that direction, and never a second time.

What you need to document

The paperwork is what turns a correct calculation into a defensible one, and most of it has to exist before the first payment goes out rather than get reconstructed later.

The exceptions analysis

A written record of which section 72(t)(2) exceptions were considered and why each was ruled out before SEPP was chosen, particularly the separation-from-service exception for anyone between 55 and 59½.

The computation workpaper

The valuation date and balance used, the method and table selected, the interest rate and its source month, and the resulting payment, kept and reconfirmed every year the program runs.

The account-partition record, if one exists

If the program runs on a slice of a larger IRA rather than the whole account, the paperwork showing the split happened before the balance was valued, and a clean history showing the two accounts were never recombined or cross-funded once the program began.

The distribution-code check

Each year's Form 1099-R, confirming whether the custodian used box 7 code 2, for a known exception, or code 1, for none. Where code 1 appears, Form 5329, Part I is required, with the taxable amount on line 1 and, on line 2, the excepted amount under exception number 02, checked every year rather than assumed to carry forward.

Where it goes wrong

A SEPP program is not a controversy risk in the way a listed transaction is. The calculation methods, the rate cap, and the modification rule are all published guidance, not a position the IRS is likely to challenge on its merits. The risk here is mechanical: a program that gets modified reports its own failure on the return for the year it happened.

A modification reaches back through every prior year

Section 72(t)(4) describes what happens if the series is modified, other than by the taxpayer's death or disability or the rollover-continuation relief, before the later of the five-year date or age 59½. The tax for the first year of the modification is increased by the 10% that would have applied in every prior year of the program, plus interest for each of those years. A break in year three of a program does not just cost the tax on year three's distribution. It reopens every distribution paid since the program began.

The recurring mistakes

• Rounding a payment for convenience, or skipping a year and taking an extra distribution to compensate. Either one changes the pattern the exception depends on.
• Adding money to the account. This counts even when the deposit has nothing to do with the SEPP program itself.
• Moving part of the account elsewhere. This includes reuniting a partitioned-off sibling IRA with the SEPP account once the program has started.
• Switching methods in the wrong direction, or a second time. Only the one move, from a fixed method to the RMD method, is permitted.
• Stopping at five years when the taxpayer has not yet turned 59½. This is the most common client-driven mistake, because the five-year number is memorable and the "later of" language is not.

Not every change to the numbers is a modification. Notice 2022-6 treats complete depletion of the account by the payments themselves, and the smaller or final payment that results, as no modification at all, and the same is true of the one-time switch to the RMD method and of the taxpayer's death or disability. Knowing this list keeps a client from an unnecessary fix the rule already excuses.

A situation where this comes up

The clearest case is a business owner in their early fifties who has just sold or exited the business and needs bridge income before other resources become available. Often that owner has been running as an S corporation, for the reasons in my Florida S-corp guide, and the sale ends the W-2 income it was paying. If most of what is left sits in a traditional IRA and the household has little other income that year, a SEPP program can carry the whole income plan until 59½. The three methods trade size for flexibility: the RMD method produces the smallest payment and recalculates every year, while either fixed method locks in a larger, steadier number for a commitment that runs well past five years starting in the early fifties.

The situation I stop most often is a client between 55 and 59½ about to roll an old employer plan into an IRA, usually for consolidation, without realizing that move gives up a free exception. If separation from service already happened, that money can come out of the plan directly with no formula and no commitment; rolling to an IRA first trades that away for a SEPP program the client did not need.

The third pattern worth naming is the client who assumes SEPP is required on a Roth IRA and is surprised it may not be yet. Distributions that stay inside years of contributions create no income, so the 10% question never comes up, until a smaller Roth relative to contribution history, or a large bridge-income need, reaches the conversion or earnings layer.