Retirement Plans FAQs regarding Substantially Equal Periodic Payments
These frequently asked questions and answers provide general information and should not be cited as any type of legal authority. They provide the user with information responsive to general inquiries. Because these answers do not apply to every situation, yours may require additional research.
The freely available Adobe Acrobat Reader software is required to view, print, and search the questions and answers listed below.
Is there an additional income tax on early distributions from retirement plans and IRAs?
An additional 10% tax applies to early distributions (before the participant reaches age 59½) from a retirement plan or IRA under Code §72(t)(1). Section 72(t)(2) lists exceptions to this tax, including distributions received in substantially equal periodic payments.
Is there an exception to the tax for distributions in substantially equal periodic payments?
Yes. If distributions are made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary, the §72(t) tax does not apply. If these distributions are from a qualified plan, not an IRA, you must separate from service with the employer maintaining the plan before the payments begin for this exception to apply. If the series of substantially equal periodic payments is subsequently modified (other than by reason of death or disability) within 5 years of the date of the first payment, or, if later, age 59½, the exception to the 10% tax does not apply. In that case, your tax for the modification year is increased by the amount that would have been imposed (but for the exception), plus interest for the deferral period.
Is there guidance on this exception?
Yes. Rev. Rul. 2002-62 lists three methods you may use in determining what are substantially equal periodic payments:
All three methods require the use of a life expectancy or mortality table. The second and third methods require you to specify an acceptable interest rate.
How are interest rates determined?
You may use any interest rate that is not more than 120% of the federal mid-term rate published in IRS revenue rulings for either of the two months immediately before distributions begin.
How is life expectancy determined?
You may use the:
How is the account balance determined?
The account balance may be determined in any reasonable manner based on the facts and circumstances.
How are payments determined under the three methods?
Bob, age 50, is the owner of an IRA from which he would like to start taking distributions beginning in 2011. He would like to avoid the §72(t) additional 10% tax imposed on early distributions by taking advantage of the substantially-equal-periodic-payment exception.
Required minimum distribution method
The required minimum distribution method consists of an account balance and a life expectancy (single life or uniform life or joint life and last survivor each using attained age(s) in the distribution calculation year). The annual payment is redetermined each year.
For 2011, the annual distribution amount is calculated by dividing the December 31, 2010, account balance ($400,000) by the single life expectancy (34.2) obtained from I.T. Regs. §1.401(a)(9)-9 Q&A-1, using age 50 ($400,000/34.2 = $11,696).
For subsequent years, the annual distribution amount will be calculated by dividing the account balance as of December 31 of the prior year by the single life expectancy. Use the same single life expectancy table used in prior year calculations, but use the current age. For example, if Bob's IRA account balance, after the 2011 distribution has been paid, is $408,304 on December 31, 2011, the annual distribution amount for 2012 ($12,261) is calculated by dividing the December 31, 2011 account balance ($408,304) by the single life expectancy (33.3) obtained from Q&A-1 of I.T Regulations §1.401(a)(9)-9 using age 51 ($408,304/33.3 = $12,261).
Fixed amortization method
The fixed amortization method consists of an account balance amortized over a specified number of years equal to life expectancy (single life uniform life or joint life and last survivor) and an interest rate of not more than 120% of the federal mid-term rate. Once an annual distribution amount is calculated under this method, the same dollar amount must be distributed in subsequent years.
For 2011, the annual distribution amount is calculated by amortizing the account balance ($400,000) over a number of years equal to Bob’s single life expectancy (34.2) (obtained from Q&A-1 of I.T. Regs. §1.401(a)(9)-9 using age 50), at a 2.98% interest rate (April 2011 rates). The annual distribution amount is $18,811.
Fixed annuitization method
The fixed annuitization method consists of an account balance, an annuity factor and an annual payment. The annuity factor is calculated based on the mortality table in Appendix B of Rev. Rul. 2002-62 and an interest rate of not more than 120% of the federal mid-term rate. Once an annual distribution amount is calculated under this method, the same dollar amount must be distributed in subsequent years.
Under this method the annual distribution amount is equal to the account balance ($400,000) divided by an annuity factor that would provide one dollar per year over Bob’s life, beginning at age 50. The age 50 annuity factor (21.345) is calculated based on the Rev. Rul. 2002-62 Appendix B mortality table and an interest rate of 2.98%. The annual distribution amount is calculated as $400,000/21.345 = $18,740.
Can I change from one method to another in calculating substantially equal periodic payments?
Yes. Rev. Rul. 2002-62 permits a one-time change from either the amortization method or the annuitization method to the required minimum distribution method.
For example, assume Sam started receiving distributions from his IRA in annual substantially equal periodic payments in 2007 at age 50. His annual payment of $65,809 was originally calculated using the amortization method. Sam would like to use the special rule in Rev. Rul. 2002-62 allowing a one-time change to the required minimum distribution method to determine a new annual distribution amount beginning in 2011. For this one-time change in method, Sam will determine an annual distribution amount for 2011 using his IRA account balance on March 31, 2011 ($750,000), and a single life expectancy of 30.5 (obtained from Regulations §1.401(a)(9)-9, Q&A-1, using age 54).
Under the new method, the 2011 distribution amount is $24,590 ($750,000/30.5). Sam must use the required minimum distribution method to determine the annual distribution amount for subsequent years.
What is the effect of an account being completely depleted?
If you have no assets remaining in your individual account plan or IRA, you will not be subject to the Code §72(t) tax as a result of not receiving substantially equal periodic payments. In addition, the recapture tax will not apply.
Are these methods the only acceptable ways of determining substantially equal periodic payments?
No. Another method may be used in a private letter ruling request, but, of course, it would be subject to individual analysis.
Can I take my substantially equal payments on a monthly basis?
The simple answer is yes. Your monthly payment under the required minimum distribution method would be the calculated annual amount divided by 12. Under the amortization and annuity methods, the choice of a having the payment made monthly should be part of the original calculation.
When do I fulfill my obligation to take substantially equal periodic payments?
The substantially equal period payments must generally continue for at least five full years, or if later, until age 59 ½. For example, if you began taking payments at age 56 on December 1, 2006, you may not take a different distribution or alter the amount of the payment until December 1, 2011, even though your fifth payment was taken on December 1, 2010.
If you begin taking substantially equal periodic payments on December 1, 2005, and you turn 59 ½ on July 1, 2011, you may not take a different distribution or alter the amount of the payment until July 1, 2011.