Distributions from IRA accounts are subject to income tax at the time of withdrawal. If a distribution is taken before the account owner reaches age 59 ½, an additional 10% tax penalty is imposed, unless one of the exceptions applies. They include: distributions for qualified medical expenses, qualified education expenses, first-time home purchase, health insurance premiums paid by the unemployed, qualified hurricane distributions, and qualified reservist distributions for the military. There are special conditions outlined in the Internal Revenue Code which further qualify when these exemptions may be used. Another exception, frequently used by those who need to access their IRAs before age 59 ½ but unable to rely on any of the exceptions outlined above, is called a series of substantially equal periodic payments (SEPP).
In essence, the IRS is willing to waive the pre-mature distribution penalty for those account holders who agree to take a series of payments for a specified period of time. The rules are complex and individuals should seek advice of a qualified tax advisor before commencing distributions because penalties for improper distributions are hefty and have an effect of undoing the entire series of payments subjecting them to 10% penalty and interest charges.
Amounts of desired distributions will vary from client to client, so it’s important to understand options for determination of these amounts. The method chosen to calculate the first year’s distribution must be used consistently in subsequent years. There are three methods to determine the distribution amount; each method produces a different annual withdrawal:
• Required Minimum Distribution (RMD) Method: The payment amount for any tax year is determined by dividing the value of account for that year by the owner’s current life expectancy taken from one of three IRS tables. A separate calculation is required every year, and withdrawal amount fluctuates from year to year.
• Fixed Amortization Method: The fixed amortization method results in a consistent annual payment throughout the series. In the first year, the payment is determined by amortizing the account balance over a specific number of years (based on the life expectancy from one of the IRS tables) with the chosen interest rate. Amount remains level throughout the series of distributions.
• Fixed Annuitization Method: This method also produces a level annual payment throughout the series. The annual payment is determined by dividing the account balance in the first year by an annuity factor which represents the present value of an annuity of $1 per year beginning at the IRA owner’s age and extending through life expectancy. The annuity factor is taken from the IRS-mandated mortality table in Appendix B of Revenue Ruling 2002-62 with the interest rate determined by account owner. The Service provides guidance on how to determine the interest rate range available for calculation purposes.
A few other important pointers:
• Account owner must withdraw substantially equal amounts from the IRA annually.
• Once started, payments must continue for the required duration: the later of five years or attainment of age 59 ½.
• The payment can be altered without penalty due to death or disability.
• There is a one-time opportunity to change to the Required Minimum Distribution method. One is allowed to change the method from either the fixed annuitization method or the fixed amortization method to the Required Minimum Distribution method.
First Allied Retirement Services developed a variety of tools, reports, and materials to assist you in effective communication about these and other important retirement topics. The rules are complex and to succeed you need to either become an expert or align yourself with the right partner. We are available to be an extension of your team. Retirement Services consultants are ready to partner with you in presenting solutions to your clients and prospects. But we don’t stop there; we help you implement and maintain the plan in partnership with nationally recognized record keeping vendors to offer a complete plan solution. You can reach us at (888) 926-0600 or via email to firstname.lastname@example.org.