This article was posted on December 1, 2002.
In October 2002 the Treasury Department and the Internal Revenue Service released Revenue Ruling 2002-62 which allows taxpayers to preserve their retirement savings after a large drop in the value of their retirement portfolio. The Treasury also clarified some of the rules governing the 72(t) exception 'substantially equal period payments' (SEPP) in this new ruling. If you want to read a copy of the Treasury's Oct 3, 2002 Press Release, click here.
Here's a summary of Revenue Ruling 2002-62:
1) Busted SEPPs. If you have been following an approved SEPP program and losing investments deplete your IRA before age 59-1/2, the IRS will not assess the 10% penalty and retroactive interest changes that usually result upon a modification to the annual distribution.
Additionally, if you have been using the amortization or annuity method, you may make a one time change to the Minimum Distribution method. For a given IRA balance, this will reduce the annual distribution and allow the remaining portfolio to last longer.
2) Interest Rates. The interest rate that may be used for the amortization or annuity methods is any interest rate that is not more than 120 percent of the Federal mid-term rate for either of the two months immediately preceding the month in which the distribution begins. For example, if you make your first distribution in July, you may use either the May or June interest rate.
120% Mid-Term Annual Applicable Federal Rates
3) Account Balance. You may make the distribution calculation based on the account balance on December 31 of the previous year or any date in the current year prior to the first distribution. For example, for an IRA with daily valuations that made its first distribution on July 15, 2003, it would be reasonable to determine the yearly account balance when using the required minimum distribution method based on the value of the IRA from December 31, 2002 to July 15, 2003. For subsequent years, under the required minimum distribution method, it would be reasonable to use the value either on the December 31 of the prior year or on a date within a reasonable period before that year’s distribution. .(Note: Just to be safe, once you've chosen a valuation date, I'd use the same date in subsequent years. If you use the March 31st account balance the first year, I'd use March 31st in subsequent years.)
4) Life Expectancy Tables for the Minimum Distribution and Amortization Methods. Taxpayers may use any one of the three life expectancy tables in Publication 590--June 2002 Supplement.) Most retirees will prefer using Table 1 - Single Life Expectancy since it yields the highest annual distribution of the three.
5) Mortality Table for the Annuity Method. A new mortality table for the annuity method is provided and must be used for SEPPs starting on or after January 1, 2003. You can find it in Appendix B of Revenue Ruling 2002-62.
The new Retire Early Annuity Factor Calculator spreadsheet incorporates all of these changes and provides the annual distribution amount for each of the three IRS approved methods.
Discussion of the New Rules for 2003
1) Busted SEPPs. This is good news for those who attempted to take a SEPP using the annuity method with a high interest rate or from a concentrated portfolio and have suffered severe losses. If you invested primarily in something like Enron or WorldCom, your portfolio could be close to zero by now. The opportunity to make a penalty-free change to the minimum distribution method will offer some belated relief -- at least from the IRS penalties.
On the other hand, if you invested in Dell or Microsoft ten years ago and your portfolio has grown appreciably, you could also benefit from a change to the minimum distribution method. For example, let's say a 40-year-old started a SEPP eight years ago in November 1994 when 120% of the Long-Term Federal applicable rate was 9.61%. Using the UP-1984 Mortality Table and the annuity method, the fixed annual withdrawal in 1994 would be $9,456 from a $100,000 IRA. If the portfolio had grown to $1 million today, our now 48-year old retiree could switch to the minimum distribution method and take $27,780 from a $1 million IRA in 2002. That's almost a three-fold increase in the annual IRA distribution without incurring a penalty.
2) Interest Rates. The new rules that take effect on Jan. 1, 2003 require that the interest rate not exceed 120% of the Mid-Term Applicable Federal rate and also require the use of a new mortality table which futher reduces the size of the annual withdrawal. Currently, 120% of the Long-term rate may be used with the UP-1984 Morality Table. The difference between the old and new rules is shown below.
If you want a larger annual distribution, make sure to start your SEPP before Jan. 1, 2003 and use the old rules to make the calculation.
3) Inflation Adjustments and Annual Recalculation with the Annuity and Amorization Methods. There have been several IRS private letter rulings (PLRs) allowing for annual recalculation with the annuity and amorization methods as well as several allowing the annual SEPP distribution to be increased for inflation or "cost of living" (see PLRs 9503631, 9726035 and 9816028.) Revenue Ruling 2002-62 is silent on these method variations and there have been no authoritative published references giving guidance on whether annual recalculation or inflation adjustments with the annuity or amortization methods are permissible under the new rules.
If you want to use either of these method variations for a SEPP starting on or after Jan. 1, 2003, it's probably best to request an IRS private letter ruling on the issue, or wait until another taxpayer spends a few thousand dollars asking the question and the IRS publishes a positive ruling. Then you'll have the answer for free.
4) New Life Expectancy and Mortality Tables. The new single life expectancy table (Table 1 - Publication 590) for the minumum method adds about one year to the life expectancy of a 50-year-old. The new mortality table in Appendix B, Revenue Ruling 2002-62 adds about 8 years to the life expectancy of a 50-year-old versus the old UP-1984 Mortality Table. Both of these changes reduce the size of the permissible SEPP distribution.
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Copyright © 2002 John P. Greaney, All rights reserved.