This article was first posted on August 9, 2004, updated January 18, 2005.
In addition to the three methods for calculating "substantially equal periodic payments" (SEPP) outlined in the Internal Revenue Service Revenue Ruling 2002-62, there have been two IRS private letter rulings (PLR) allowing for recalculation using the amortization method (PLRs plr200432021, and plr200432024.) and one using the annuity factor method plr200432023.)
The common theme in these three PLRs is that the taxpayer recalculates the SEPP distribution using a new IRA balance and interest rate each year, along with being a year older when entering age into the calculation. The other requirements are that you value your IRA on the same day each year and use the same type of interest rate in the same month. For example, if you use the 120% of the January mid-term applicable Federal rate in the first year, you can't use 100% of the May mid-term applicable Federal rate in the second year of your SEPP. You must select the January value for 120% of the mid-term applicable Federal rate in each year of your SEPP program.
You must also use the same mortality table to make the calculation each year. The UP-1984 Mortality Table yields the highest withdrawal among the nine or ten mortality tables approved by the IRS Commissioner, thus it makes the most sense to use that.
Here's an example for a 42 year old taking a first SEPP distribution in 1998 using December 31 (of the previous year) to determine the IRA balance and the January long-term applicable Federal rate.
With recalculation, the annual withdrawal amount rises and falls with the IRA account balance and interest rate used each year. It also rises slightly with age as the retiree's remaining life expectancy dwindles. It may be necessary for a retiree to have funds outside of the IRA that can be tapped at will to cope with the variation in SEPP withdrawals.
An updated version of the Retire Early Amortization Calculator is available to allow retirees to better track their SEPP distributions as they change from year to year with recalculation. Despite what the "experts" say, if you are organized, it's no more difficult than using the standard annuity factor method.
Since the recalculation method eliminates the risk of depleting the account before age 59-1/2, it is possible to use the maximum allowable interest rate (120% of the mid-term applicable Federal rate) without fear of penalty if the stock market goes against you.
Let's say a 45-year-old retiree wants a 4% withdrawal ($40,000 per year) from a $1 million IRA. Instead of using the entire IRA, he could split it into two IRAs, $550,000 and $450,000. Using 120% of the January 2002 mid-term rate (6.55%) and the $550,000 IRA, the first year SEPP withdrawal is $41,201. The smaller $450,000 IRA could then be held in reserve to fund Roth IRA rollovers, education or "first home" withdrawals, or a new SEPP distribution program in the future if required.
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