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You’re taking periodic payments from an IRA or 401(k) plan

Posted On: FEBRUARY 2023

A tax-advantaged savings plan, such as an IRA or 401(k) plan, is designed to help you fund your retirement. But to the extent that you don’t need the funds during your golden years, they can be a valuable supplement to your estate plan. To preserve the tax-deferred growth of these funds, it’s best to avoid early withdrawals (before age 59½), which can trigger a 10% penalty, on top of ordinary income taxes.

If you need to take early withdrawals, it’s possible to avoid penalties under limited circumstances. One way to do so is to take a series of substantially equal periodic payments (SOSEPP) over your life expectancy or the joint life expectancies of you and your designated beneficiary. But if you go this route, be sure you understand the rules to avoid potentially costly pitfalls.

To calculate the payment amount, you can

1. Divide your account balance at the end of each year of your life expectancy or the joint life expectancies for you and your beneficiaries according to IRS tables,

2. Amortize your account balance over a period of years based on applicable life expectancy tables and a “reasonable” rate of interest, or

3. Divide your account balance by an IRS-prescribed annuity factor.

Be aware that payments under method number one fluctuate, while methods numbers two and three result in fixed payments. Also, in the case of an employer-sponsored retirement plan that permits SOSEPPs, you must leave your job before payments begin.

Once you start periodic payments, they must continue for at least five years or until you reach age 59½, whichever is longer. If you modify the amount of a payment or make any other additions to or distributions from the account, the arrangement may be disqualified, triggering tax penalties and interest on all previous payments.

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