Figuring Substantially Equal Periodic Payments

Yesterday I described a way to avoid the 10% penalty tax on distributions from an IRA before age 59-1/2 by taking “substantially equal periodic payments.” Today’s post describes how to figure your distributions to meet this exception. Basically, the IRS has approved three methods for calculating “substantially equal” distributions.

Required Minimum Distribution method. Under this method, you determine your annual distributions by dividing your account balance by your remaining life expectancy. To get your life expectancy, you have the option of using (i) your single life expectancy, or (ii) the joint life expectancy of you and your beneficiary, or (iii) a table created by the IRS called the Uniform Lifetime Table. These three tables can be found in the appendix to IRS Publication 590, here:
http://www.irs.gov/pub/irs-pdf/p590.pdf

Once you select one of the three tables, you must stick with it. Each year you redetermine the appropriate life expectancy by going back to the selected table and getting a new divisor based on your attained age or ages in that year. The Required Minimum Distribution method results in a relatively low initial distribution, which then tends to grow over the years.

Life expectancy amortization method. Under this method, you determine an annual distribution by amortizing the IRA’s current value over a life expectancy. This method results in a fixed annual distribution which doesn’t change from year to year. You can do the amortization calculation using a financial calculator. In doing the calculation, you may get your life expectancy from one of the three tables described above; and you may choose any interest rate that does not exceed 120% of a rate published monthly by the IRS (called the federal mid-term rate) for either of the two months preceding the month your distributions begin. The IRS-published rates can be found on their website here:
http://www.irs.gov/app/picklist/list/federalRates.html

Mortality table method. Under this method, you determine an annual distribution by dividing your IRA balance by an annuity factor to be derived from an actuarial mortality table published by the IRS. Like the Life Expectancy Amortization method, this method results in a fixed amount which does not change from year to year. The services of an actuary are needed, making this method inconvenient.

The IRS has approved other methods for determining substantially equal periodic payments from an IRA, but only in private letter rulings, on which you may not rely (as time goes by). So if you act on the advice given in the ruling, you do so at your own risk.

In yesterday’s post, I mentioned that once you start on these distributions, you may not deviate from them without incurring substantial penalties. But here’s an exception: If you have been calculating your periodic distributions under either the Life Expectancy Amortization method or the Mortality Table method (both of which result in a fixed distribution), you are allowed to make a one-time switch to the Required Minimum Distribution method (but not back again) without incurring a penalty recapture tax.

Now that you know how to take IRA distributions before age 59-1/2 without penalty, let me ask you this: Why are you doing this?