The Internal Revenue Service (IRS) released Notice 2022-6, which provides new guidance on whether a series of payments from an individual account under a qualified retirement plan is considered a series of substantially equal periodic payments within the meaning of section 72(t)(2)(A)(iv) of the Internal Revenue Code (the “Code”). The guidance provides a five percent floor on the maximum interest rate that may be used and provides an updated life expectancy table in Appendix A of the Notice.

Effective Date

The new guidance is effective for any series of payments commencing on or after January 1, 2023 and may be used for a series of payments commencing in 2022.

Background

Section 72(t) provides for an additional income tax on early withdrawals (generally withdrawals before age 59½) from qualified retirement plans equal to 10% of the amount of the withdrawal that is includible in gross income. Section 72(t)(2) provides some exceptions to the 10% additional tax. One exception is for distributions that are part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of the employee and designated beneficiary. Section 72(t)(4) provides that if a distribution is excepted from the 10% additional tax as part of a series of substantially equal periodic payments and that series of payments is subsequently modified (other than by reason of death, disability, or a distribution to qualified public safety employees in governmental plans) within the first five years or before the employee attains age 59½, then the employee's tax for the first year of the modification is increased by an amount equal to the tax that, but for the exception from the 10% tax, would have been imposed, plus interest for the deferral period (the “recapture tax”).

Notice 89-25 provides that payments are considered to be substantially equal periodic payments if they are made in accordance with one of the following three methods: (1) the required minimum distribution method; (2) the fixed amortization method; or (3) the fixed annuitization method.

Rev. Rul. 2002-62 modified the application of the fixed amortization method and the fixed annuitization method by providing that the interest rate that may be used to apply the fixed amortization method or the fixed annuitization method is any interest rate that is not greater than 120% of the federal mid-term rate for either of the two months immediately preceding the month in which the distribution begins). In addition, Rev. Rul. 2002-62 modified the application of the fixed annuitization method by specifying the mortality table that must be used to apply that method.

Final regulations under section 401(a)(9) of the Code that were issued in 2020 provided new life expectancy tables for determining required minimum distributions that apply for distribution calendar years beginning on or after January 1, 2022.

Notice 2022-6

Notice 2022-6 modifies and supersedes Rev. Rul. 2002-62 and Notice 2004-15 (relating to distributions from non-qualified annuity contracts).  In general, the overall methodology has not been changed.  Therefore, Notice 2022-6  provides as follows:

• Three Methods: Payments in a series are considered substantially equal periodic payments if they are determined in accordance with one of the three methods described below:
  • The required minimum distribution method. The annual payment for each distribution year is determined by dividing the account balance for that distribution year by the number of years from the chosen life expectancy table for that distribution year. Under this method, the account balance, the number of years from the chosen life expectancy table, and the resulting annual payments are re-determined for each distribution year. This redetermination of the annual payment is not considered a modification of the series of substantially equal periodic payments, provided that the required minimum distribution method continues to be used and the same life expectancy tables continue to be used, except to the extent required the rules of section 401(a)(9) for the designated beneficiary require a different beneficiary age to be used under the Joint and Last Survivor Table when there is more than one designated beneficiary.
  • The fixed amortization method. The annual payment for each distribution year is determined as the amount that will result in the level amortization of the account balance over a specified number of years determined using the chosen life expectancy table and a permitted interest rate. Under this method, once the account balance, the number of years from the chosen life expectancy table, and the resulting annual payment are determined for the first distribution year, the annual payment is the same amount in each succeeding distribution year.
  • The fixed annuitization method. The annual payment for each distribution year is determined by dividing the account balance by an annuity factor that is the present value of an annuity of $1 per year beginning at the employee's age and continuing for the life of the employee (or the joint lives of the employee and designated beneficiary). The annuity factor is derived using the mortality rates set forth in § 1.401(a)(9)-9(e) of the Income Tax Regulations (the regulations) and a permitted interest rate. Under this method, once the account balance, the annuity factor, and the resulting annual payment are determined for the first distribution year, the annual payment is the same amount in each succeeding distribution year.
• Life Expectancy Tables. The life expectancy tables that can be used to determine distribution periods under the required minimum distribution and fixed amortization methods are: (1) the Uniform Lifetime Table in Appendix A of Notice 2022-6; (2) the Single Life Table in § 1.401(a)(9)-9(b) of the regulations; or (3) the Joint and Last Survivor Table in § 1.401(a)(9)-9(d) of the regulations (which can be used even if the designated beneficiary is not the spouse).
• Permitted Interest Rates. The interest rate that may be used to apply the fixed amortization method or the fixed annuitization method is any interest rate that is not more than the greater of (i) 5% or (ii) 120% of the federal mid-term rate (determined in accordance with Code § 1274(d) for either of the two months immediately preceding the month in which the distribution begins). The federal mid-term rates may be found at https://apps.irs.gov/app/picklist/list/federalRates.html.

CHEIRON OBSERVATION:   The use of the 5% interest rate is a substantial change from the previous rules and will greatly increase the amount that can be paid under the fixed amortization and fixed annuitization methods. For example, using a life expectancy of 48.5 years (from the uniform table for age 50), an interest rate of 5%, the annual payment under the fixed amortization method would be about 80% higher than if the interest rate of 1.68% (from the February 2022 federal mid-term rates) was used.

• One-Time Change From Fixed Amortization Method or Fixed Annuitization Method to Required Minimum Distribution Method. An individual who begins distributions using either the fixed amortization method or the fixed annuitization method is permitted in any subsequent distribution year to make a switch to the required minimum distribution method to determine the payment for the distribution year of the switch and all subsequent distribution years. This change in method will not be treated as a modification, but any subsequent change from the required minimum distribution method will be a modification for purposes of the recapture tax.

Transition Rule

In the case of a series of payments commencing in a year prior to 2023 using the required minimum distribution method, if the payments in the series are calculated by substituting the Single Life Table, the Joint and Last Survivor Table, or the Uniform Lifetime Table described in Notice 2022-6 for the corresponding table that was used under Rev. Rul. 2002-62, then the substitution will not be treated as a modification. within the meaning of section 72(t)(4).

Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Accordingly, we do not provide legal services or tax advice.