Once funds are inside the shelter of an IRA or non-qualified annuity, they are typically locked away until the account owner has reached age 59.5. Accessing funds prior to this time will result in the imposition of an additional 10% penalty tax without an approved exception. Section 72(t) of the Internal Revenue Code [IRC] provides both the problem and the solution.
The Problem... Section 72(t) provides that amounts distributed from a traditional IRA or a Roth IRA before an individual reaches age 59-1/2 are classified as premature distributions. To the extent such distributions are taxable as income, they are also subject to an additional tax equal to 10% of the amount of the distribution. Section 72(q) applies to non-qualified annuities and works in a similar fashion.
The Solution... The 10% penalty tax does not apply to distributions which are part of a series of substantially equal periodic payments made at least annually for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his designated beneficiary. The IRS codes that deal with this exception are 72(t)(2)(A)(iv) and 72(t)(4)(A).
IRS Notice 89-25 describes (and Revenue Ruling 2002-62 continues the) three basic methods in which payments will be considered to be substantially equal periodic payments:
- The life expectancy method - calculated under the minimum distribution rules;
- The amortization method - amortize account balance using life expectancies and a reasonable interest rate;
- And the annuitization method - account balance divided by an annuity factor using both a reasonable mortality table and interest rate.
Don't just accept the results of a web calculator - check them out to see if they match the results that the IRS produced and used in both IRS Notice 89-25 and Rev. Rul. 2002-62.
From 2002-62 FAQ: Male Age 50, 4.5% Interest, $400,000 IRA
- Life Expectancy: 34.2 years
- Minimum Distribution: $11,695.91
- Amortized Payment: $23,134.27
- Annuity Payment: $22906.68