Substantially Equal Payment Exception

The decline in the stock market has adversely affected the value of taxpayer’s retirement investments. This decline in value of retirement accounts has uniquely affected taxpayers who have taken early retirement.

Generally, taxpayers who withdraw from their pension plans including IRAs before reaching age 59 ½ are subject to the 10% early withdrawal penalty. However, taxpayers who retire can avoid that penalty by using a special exception that requires that they take substantially equal payments from their pension plan for a period of time that is the longer of five years or the until they reach 59 ½.

The substantially equal payments are computed based on the value of the retirement account. Those retirees who retired before the decline in the market may have substantially equal payments that are excessive for account that have substantially declined in value and are depleting the plan to a point that future recovery is threatened.

Because of this, the IRS has announced that it will allow taxpayers to make a one-time change to the Minimum Required Distribution method, which is the same method used by individuals who have reached the age of 70 ½.

This one-time change will only allow a taxpayer to switch to the Required Minimum Distribution (RMD) method. Caution: switching to the RMD may substantially reduce the annual distribution and may not allow an affected taxpayer to withdraw enough to meet their current financial obligations while they wait to meet the 5-year or age 59 ½ rule. Many of them are counting on the early pension withdrawals until they start receiving their Social Security or employer retirement. Once they switch, they cannot increase or decrease their withdrawal without violating the exception.

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