SEPP 72t AND 5 Year Roth Conversion

[Arioch]

I’m interested in finding out more about using both SEPP and Roth Conversion rules to withdraw from 401k holdings before age 59.5 without the 10% early withdrawal penalty.

I see a lot of great info about how to do one or the other but not much on using both at the same time. Can this be done with only 1 401k and 1 Roth account, or would additional accounts be required? Has anyone actually done this? Any gotchas?

Thanks in advance for any advice!

[Eric]

You can do both at the same time if it's advantageous to do so, with some restrictions.  I don't believe you can convert t-IRA funds to Roth IRA from the same account that you're drawing SEPP from.  This is because the IRS has restrictions on the amount you can withdrawal based on the account balance, and pulling other amounts from the same account would cause you to be in violation of those restrictions.  However, you absolutely can split your t-IRA into separate accounts in order to start the SEPP on one of them.  This can be helpful to make it match your desired withdrawal amount, since the framework for SEPP withdrawals is not all that flexible.

Just know that the t-IRA to Roth IRA conversion is a taxable event (taxed as ordinary income), and the SEPP withdrawal is a taxable event (taxed as ordinary income), so if you're doing both at the same time, that could result in a relatively high tax bill.  This is generally why you don't see much written about combining them.  However, in a specific circumstance, it could be the right choice.

Personally, I'm thinking I may "front load" my low tax years, by converting to Roth only up to the standard deduction amounts each year.  However, this is not enough for me to live on.  Then when the conversions run out, I would start SEPP to make up the shortfall.

[Arioch]

Great info, thanks!

Somehow I had the impression the SEPP withdrawal amounts were based on the value of the traditional IRA at the time SEPP starts as opposed to any restrictions based on the current balance at the time of the withdrawal.

[Eric]

Great info, thanks!

Somehow I had the impression the SEPP withdrawal amounts were based on the value of the traditional IRA at the time SEPP starts as opposed to any restrictions based on the current balance at the time of the withdrawal.

You're correct that withdrawal amounts are based on that starting balance.  But the way that the withdrawal amount is calculated, it's based on a conservative withdrawal rate, since the point of the program is to allow you access, but not allow you to deplete the account.

According to Vanguard, you can't really make any changes to the IRA once you've started SEPP.  (This even includes adding funds to the IRA). 

Can I take more than the SEPP amount from my IRA or retirement plan?

In most situations, you won’t be able to take additional money from your IRA or retirement plan because the IRS considers this a modification to the SEPP. Other than modifications expressly permitted by law, modifying your SEPP will subject you to the early distribution penalty tax for all payments taken under the SEPP, plus interest. Please consult yourtax advisor for more information.

More FAQs here:

https://personal.vanguard.com/pdf/s164.pdf

[Arioch]

Makes perfect sense, thanks again for the excellent explanation and the links. I was forgetting the whole point of the SEPP withdrawal calculation when I started going down this line of thinking.

I can’t seem to stop trying to think of new ways to bring FIRE closer!

[josh4trunks]

I am nowhere near retirement, and have not implemented any of these strategies, but have researched and thought about SEPP and Roth conversions alot. Something that has interested me is the potential to maximize the utilization of SEPP for early retires.

SEPP's advantage to the Roth Conversion Ladder is being able to access some funds immediately from an IRA account.
SEPP's disadvantage is not being able to fully utilize the funds designated to SEPP before age 59.5 because the withdrawal rate is so conservative.

But I believe there is a method to more completely utilize money designated to SEPP. This is not necessarily useful for everyone, but is another tool that gives flexibility during ER.
You can do Roth conversions of money in a SEPP account. Your SEPP IRA, and newly created Roth SEPP IRA are together under the same SEPP rules. Your yearly withdrawal can be from either account (or split between both) as long as the total withdrawn is still correct. Also realize Roth's withdrawal order does not care what account your withdraw from. So you could do conversions from your SEPP IRA to your SEPP Roth IRA, then (5 years later) do withdrawals from a standard Roth IRA account. In a sense, you could access Roth gains accrued in a standard Roth IRA account, by using the conversions done between your SEPP accounts.

A potential strategy here is...
Traditional IRA - Rollover 401k into this account.
Roth IRA - Contribute to this account if you are above the traditional IRA limits. Gains will be accessible without tax because of Roth conversions between SEPP accounts.
SEPP IRA - Move over some amount from your Traditional IRA (https://www.bankrate.com/calculators/retirement/72-t-distribution-calculator.aspx)
Roth SEPP IRA - Do conversions from SEPP IRA into this account. This money can be used after 59.5.

[chasesfish]

I'm bumping this thread up and want to add a little bit to it....

There are a lot more risks to the 72t compared to the Roth Conversion, mainly because its not flexible to "stop" it.  The rates used are reasonable, but you have to make sure you don't have any crazy liquidity issues that stop your withdrawls.  Invest in a nice balanced mutual fund.  I think if you start doing Roth conversions with the same account you're doing a 72t, issues can come up.

I'm one of the rare people considering a 72t post retirement.  We have a nice net worth, but will be challenged with liquidity since most of this is in retirement accounts and a deferred comp plan, then what is not in retirement accounts will be tied up in stocks / funds with a lower cost basis.    10% or so of our net worth is tied up in an old Rollover IRA my wife has, which could generate another $5,000 under a 72t.  I also don't think tax rates are going to get lower than they are between now and 2025.  The RMDs are really low for people in their late 30s and it would be another nice way to convert some liquidity out.