IRS Revises Guidance on Determining Substantially Equal Periodic Payments

(Parker Tax Publishing February 2022)

The IRS has revised its guidance for determining whether a series of payments from an individual account under a qualified retirement plan are considered a series of substantially equal periodic payments within the meaning of Code Sec. 72(t)(2)(A)(iv) such that the individual receiving such payments avoids the 10-percent penalty tax under Code Sec. 72(t). The guidance supersedes Rev. Rul. 2002-62 and Notice 2004-15. Notice 2022-6.

Background

Code Sec. 72(t) generally provides that an individual who makes a withdrawal from a qualified retirement plan before the age of 59 1/2 incurs a 10 percent penalty tax on the amount withdrawn. There are several exceptions to this 10 percent penalty tax rule. One exception is Code Sec. 72(t)(2)(A)(iv), which provides that the penalty tax does not apply to 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 a designated beneficiary. The term "employee" includes any participant in the retirement plan and, in the case of distributions from an individual retirement account or annuity (IRA), the IRA owner is treated as an employee for purposes of applying Code Sec. 72(t).

Under Code Sec. 72(t)(4), if a distribution is excepted from the 10 percent penalty tax because the distribution is 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 a qualified public safety employee in a governmental plan to which Code Sec. 72(t)(10) applies) before the end of the five-year period beginning on the date of the first payment, or before the employee attains age 59 1/2, 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 in Code Sec. 72(t)(2)(A)(iv), would have been imposed, plus interest for the deferral period.

Notice 89-25, Q&A-12, provides that payments are considered to be substantially equal periodic payments under Code Sec. 72(t)(2)(A)(iv) 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. In Rev. Rul. 2002-62, the IRS 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 either method is any interest rate that is not greater than 120 percent of the federal mid-term rate (determined in accordance with Code Sec. 1274(d) for either of the two months immediately preceding the month in which the distribution begins). Rev. Rul. 2002-62 also modified the application of the fixed annuitization method by specifying the mortality table that must be used to apply that method. In Notice 2004-15, the IRS provides that taxpayers may use one of the methods set forth in Notice 89-25, as modified by Rev. Rul. 2002-62, to determine whether a distribution from a non-qualified annuity contract is part of a series of substantially equal periodic payments under Code Sec. 72(q)(2)(D).

In 2020, the IRS issued final regulations under Code Sec. 401(a)(9) which included new life expectancy tables for determining required minimum distributions that apply for calendar years beginning on or after January 1, 2022. As a result, the IRS issued Notice 2022-6, which updates the guidance for determining whether a series of payments from an individual account under a qualified retirement plan are considered a series of substantially equal periodic payments within the meaning of Code Sec. 72(t)(2)(A)(iv). The guidance in Notice 2022-6 replaces that previously issued in Rev. Rul. 2002-62 and Notice 2004-15.

Three Methods for Determining Whether Payments in a Series Are Substantially Equal Periodic Payments

In Notice 2022-6, the IRS provides that payments in a series are considered substantially equal periodic payments within the meaning of Code Sec. 72(t)(2)(A)(iv) if they are determined in accordance with one of the three methods described below.

The required minimum distribution method: Under 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 in the Appendix to Notice 2022-6 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 redetermined 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 the Joint and Last Survivor Table is required to be used.

The fixed amortization method: Under 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 in the Appendix to Notice 2022-6 and an interest rate that is permitted pursuant to Notice 2022-6. 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 in Reg. Sec. 1.401(a)(9)-9(e) and an interest rate that is permitted pursuant to Notice 2022-6. 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.

For a discussion of the exception to the 10-percent penalty tax for substantially equal periodic payments, see Parker Tax ¶71,940.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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