524 / What special rules apply to premature annuity payments that are exempt from the 10 percent penalty by reason of the “substantially equal periodic payment” (SEPP) rule if the SEPP is later modified?
Payments excepted from the 10 percent penalty ( Q 523) by reason of the substantially equal periodic payment exception may be subject to recapture if the series of payments is modified, other than by reason of death or disability, prior to the taxpayer’s reaching age 59½ or, if later, before the end of a five-year period beginning on the date of the first payment (even if the taxpayer has reached age 59½).
According to the report of the Conference Committee, the modification that triggers recapture is a change to a method of distribution that would not qualify for the exemption. The tax on the amount recaptured is imposed in the first taxable year of the modification and is equal to the tax as determined under regulations that would have been imposed, plus interest, retroactively back to the first such distribution made had the exception never applied.1
The IRS announced that the three methods used to avoid the 10 percent penalty when making substantially equal periodic payments from a qualified retirement plan ( Q 3679) also may be used to qualify as substantially equal periodic payments from a nonqualified annuity. The “one time election” to change methods also may be used by owners of nonqualified annuities. Finally, there will be no penalty if an individual depletes an account by using one of the approved methods.2
1
. H.R. Conf. Rep. No.99-841 (TRA ’86) reprinted in 1986-3 CB Vol. 4 403.