September 2010
Substantially Equal Periodic Payments (SEPP)
By James Smith, Tax and Operations Specialist
Annuities are considered long-term retirement vehicles; therefore, to discourage withdrawals prior to attaining the age of 59 ½, a federal 10 percent additional tax is imposed on premature distributions. The Internal Revenue Code provides for a few exceptions to the additional tax on premature distributions; one exception is by taking substantially equal periodic payments.
When a client initiates substantially equal periodic payments at The Standard, the payments are calculated using one of the three IRS approved methods: RMD, amortization, or annuitization. Using The Standard’s calculation ensures that the payments comply with IRS rules. The client’s IRS Form 1099-R reports an exception to the 10 percent additional tax and the endorsement is attached to the client’s policy.
However, substantially equal periodic payments are sometimes initiated without The Standard’s involvement. When this occurs, a client’s 1099-R will indicate that there is an early distribution with no known exception to the additional tax. The following are common examples of when the 1099-R reports no known exception to the additional tax:
- Purchasing a qualified immediate period-certain annuity. Although a non-qualified immediate annuity is an exception to the 10 percent tax, a qualified immediate period-certain annuity is not an exception to the additional tax, nor is it an IRS approved method in calculating substantially equal periodic payments (the calculation is based on the life expectancy of the client).
- Using multiple IRA account balances held at various financial institutions to fund substantially equal periodic payments from a policy at The Standard. A modification to substantially equal periodic payments may negate the exception to the 10 percent additional tax; a modification to the series of payments occurs if there is a change to an account balance, such as any addition, transfer, or rollover. We do not monitor IRA account balances maintained at other financial institutions to make certain that a modification does not occur. (Taxpayers file IRS Form 5329 when an exception to the tax on early distributions is met and distribution code 1, “early distribution, no known exception,” is reported on the 1099-R.)
- Selecting the Interest Paid as Earned payout option. This option is not an IRS-approved method in calculating substantially equal periodic payments.
To initiate substantially equal periodic payments at The Standard, please contact the Individual Annuities Administration team at annuityservices@standard.com or 800.247.6888. For additional information on substantially equal periodic payments, see Revenue Ruling 2002-62.