The life expectancy distribution exception primarily requires the funds to be taken based on: 1) the clients life expectancy; and, 2) continuing for a specified period of time.

The timeframe for these withdrawals must be for the greater of 5 years or the clients attaining age 59.

It is in this way that Congress and the IRS discourage individuals from utilizing their retirement accounts for short-term withdrawals. Taking distributions early requires a taxpayer to make a fairly substantial, but not insurmountable, commitment. Failing to meet these requirements will retroactively trigger the 10% premature distribution penalty on all past distributions.

The IRS has been fairly liberal when it comes to measuring a clients life expectancy. Although the Tax Code gives relatively little guidance, the IRS issued Notice 89-25 some years ago. That Notice set the standard for these calculations by detailing three key methods:

Life Expectancy Method. Similar to that used for IRA required minimum distributions. The life expectancy is determined in the first year of the distributions and reduced by one for each subsequent year. The factor is applied against the prior year-end account balance. As with IRA distributions, this amount increases annually as life expectancy is adjusted.

Amortization Method. The account balance is amortized over the clients life expectancy utilizing a reasonable interest rate.

Annuitization Method. An annuitization factor is applied against the IRA balance. This also requires the calculation to be based on reasonable mortality and interest rates. Any reasonable annuitization table may be utilized, including commercial annuitization tables or public tables based on national averages.

The effect of this flexibility is that an advisor can work with clients to pinpoint a method that suits their needs.

For example, a 50-year-old client with a $1 million IRA, with reasonable tax, mortality, and earnings assumptions, would see the following approximate results. Under the Life Expectancy approach his first year distributions would be $15,100 and the distribution at age 59 would be $26,900. Under the Amortization approach and the Annuitization approach the distributions in each year would be $38,500 and $40,800, respectively.

Clients can further hone the dollars received under a Section 72(t) program. Numerous Private Letter Rulings allow clients to segment their IRA accounts when doing their calculations for Section 72(t) purposes. This has the effect of letting them make a 72(t) election on only a portion of their retirement assets, while retaining other retirement accounts for continued tax deferred growth for retirement.

Between the range of life expectancy calculation formulas and the ability to split IRA accounts into ones against which a Section 72(t) distribution is elected, advisors can work with clients to develop a methodology that addresses the clients early income needs.

Mark Teitelbaum


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.