IRS Issues New Guidance for Substantially Equal Periodic Payments in 2022
and Subsequent Years
What Is the Impact of the Revised Life Expectancy Tables?
The IRS has issued Notice 2022-6. It modifies and supersedes its prior guidance provided in Rev. Rul. 2002-62 and Notice 2004-15 regarding substantially equal periodic payments.
The IRS continues the approach that the IRA account-holder (or the pension plan participant) may use any one of three safe harbor methods to establish their substantially equal periodic method: the amortization method, the annuity factor method or the required minimum distribution (RMD) method.
In this Notice 2022-6 the IRS updates its safe harbor approach regarding establishing a substantially equal periodic payment schedule. In theory an IRA accountholder is able to devise their own substantially equal periodic payment schedule because the statutory law does not define this term. There would be a tax risk associated with a person or adviser creating their own substantially equal periodic payment schedule. Most individuals want tax certainty and will choose to adopt one of the three IRS safe harbor methods.
This IRS guidance is to be used for any substantially equal periodic payment distribution schedule commencing on or after January 1, 2023. However, it may be used for 2022.
This guidance provides no transition rule for a schedule established prior to 2022 using the amortization method or the annuity factor method. The IRS has not granted any relief or a transition rule for those schedules established before 2022 using the amortization method or the annuity factor method. This makes sense because the annual distribution amount would decrease if the revised life expectancy tables were allowed to be used or required to be used.
In contrast, a schedule established prior to 2022 using the RMD method is allowed to use the applicable revised life expectancy table - single, joint or Uniform Lifetime table.
A person under age 59 1/2 does not owe the 10% additional tax imposed by Code section 72(t) with respect to an IRA distribution if their distribution is made pursuant to a substantially equal periodic payment schedule. The general rule is - if the schedule is changed too early the individual will have significant adverse tax consequences. The individual did not owe the 10% tax because of this exception for the year the schedule started plus subsequent years. However, if an impermissible change is made, then the person will owe this 10% tax amount related to the prior years and he or she will also owe an interest charge because that 10% amount was not paid in that prior year.
A person is able to change their schedule once he or she is age 59 1/2 or older if their schedule has been in effect for 5 years. Otherwise the change is an impermissible modification. A change is permitted to be made if the IRA accountholder dies or is disabled.
Changes in any of the following factors will generally result in an impermissible change: the life expectancy table being used, the life expectancy divisor, the interest rate, the amount of the distribution (but not for the RMD method) or the account balance. An impermissible change occurs if after the first distribution there is any addition to the account balance other than by reason of investment experience or a decrease in the account balance on account of any transfer.
Most of the new guidance provided in Notice 2022-6 applies to the RMD method. Under the RMD method the annual payment will generally change each year whereas under the other two methods the annual distribution amount once calculated is fixed and does not change.
The general rule is - the same life expectancy table that is used for the first distribution year must be used in each following distribution year. That is, you cannot change the life expectancy table after the first year. The amortization term is based on the age of the IRA owner in the first distribution year.
The IRS has issued some new guidance regarding the interest rate to be used under either the fix amortization method or the fixed annuity method. This guidance applies to such schedules established in 2022 or subsequent years. The interest rate is defined to be acceptable as long as it is not more than the greater of (i) 5% or (ii) 120% of the federal mid-term rate for either of the two months immediately preceding the month in which the distribution applies. This change is very favorable. Many IRA accountholders will elect to use the 5% rate. The higher the interest rate the larger will be the fixed payment amount. The IRS may be inferring that the use of any interest rate greater than 5% may be contested by the IRS.
Use of the RMD method requires the use of the FMV of the IRA as of the preceding December 31.
The IRS has issued some new guidance regarding the account balance if the fixed amortization method or the fixed annuity method is being used. The IRS requires the account balance must be determined in a reasonable manner based on all of the facts and circumstances. However, the IRS adopts a safe harbor, The IRA account holder may select the account balance on any date within the period which begins on the December 31 of the year prior to the first distribution and ends on the first distribution. So, there is some flexibility in choosing the account balance to be used in the calculation.
Planning Pointer. Although a person may set up their substantially equal periodic schedule using either the joint life table or the Uniform Lifetime Table it makes no sense to do so. Using either of these “joint” tables reduces the amount of the distribution because the divisor will be larger which means the distribution amount will be smaller. An IRA accountholder should maintain at least two IRAs. One IRA will have the substantially equal periodic schedule. The other will not. The second IRA exists so that if the IRA accountholder needs to withdraw IRA funds they withdraw them from the second IRA so there will no impermissible distribution from the first IRA.