PLR 200031059: IRA withdrawal schedule qualifies as substantially equal payments

Plain-English summary

A 55-year-old IRA owner asked whether withdrawals from a pool of five IRAs qualified for the substantially equal periodic payment exception to the 10 percent early distribution tax. The owner calculated the first annual amount using an annuity factor based on the UP-1984 mortality table and an 8 percent interest rate, then planned to increase the annual amount by 3 percent each year and pay it monthly. The IRS found this method consistent with the third method in Notice 89-25 and ruled that the payments met section 72(t)(2)(A)(iv). The exception remains subject to section 72(t)(4), which imposes tax and interest if the payment series is modified too soon. The letter describes transfers within the five-IRA pool with no funds entering or leaving it.

Ruling snapshot

• Question: Does the proposed withdrawal method produce substantially equal periodic payments exempt from the section 72(t) additional tax?
• Outcome: Approved under the stated method, subject to the section 72(t)(4) modification rule.
• Key authorities: IRC §§ 72(t)(2)(A)(iv), 72(t)(4), and 408(d); Notice 89-25, Q&A-12.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
200031059

Significant Index No. 72.20-04
Washington, DC 20224

Contact Person:
Telephone Number:

In Reference to: ©
T:EP:RA:T:A2
Date:
MAY 11 2000
In re: Private letter ruling on § 72(t)(20(A)(iv)

This letter is in response to your request, dated November 21, 1999, for a ruling that distributions from your individual retirement accounts (IRAs) would qualify as part of a series of substantially equal periodic payments, provided for under section 72(t)(2)(A)(iv) of the Internal Revenue Code (the “Code”).

According to the facts stated in your ruling request, you have a total of seven (7) IRAs, and one Roth IRA. Distributions commenced from five of your IRA’s beginning September 1999, and have been determined using the methodology described below. At the time of the first distribution, you were 55 years old.

The method utilized to calculate the distributions is similar to the third method described in Q&A-12 of Notice 89-25 1989-1 C.B. 662. The aggregate account balance of the five IRA’s (referred to in your submission as.

was determined as of August 1999. This aggregate account balance was divided by an annuity factor, which is the cost of an annuity of one dollar per year beginning at age 55 and paid for life, using commutation functions derived from the UP-1984 Mortality Table using an interest rate of 8 percent. The foregoing calculation determines the annual distribution to be drawn from the five IRA’s by the end of the 12-month period beginning September 1999. In subsequent years, beginning September 2000, 2001, and so on, the annual distribution amount will be increased by three percent (3%) over the prior year’s annual distribution amount. Annual distribution amounts computed for each respective 12-month period will be distributed during the respective 12-month period by dividing the distribution amount by 12 and distributing the resulting amount from one or more of the five IRA’s each month in the 12-month period.

In addition, you have stated that you may, from time to time, transfer funds from one IRA account to another within the pool of the five subject IRA’s (listed above), with the provision that

no funds outside the pool are added to the pool, and no funds within the pool are transferred outside the pool.

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Section 408(d) of the Code provides that amounts paid or distributed out of an individual retirement plan must be included in gross income by the payee or distributee in the manner provided under section 72 of the Code.

Section 72 of the Code provides rules for determining how amounts received as annuities, endowments, or life insurance contracts and distributions from qualified plans are to be taxed.

Section 72(t) was added to the Code by the Tax Reform Act of 1986 (TRA ‘86), effective generally for taxable years beginning after December 31, 1986. Section 72(t)(1) provides for the imposition of an additional 10% tax on early distributions from qualified plans, including IRA’s. The additional tax is imposed on that portion of the distribution that is includible in gross income.

Section 72(t)(2)(A)(i) of the Code provides that section 72(t)(1) shall not apply to distributions which are made on or after the date on which the employee attains age 59½.

Section 72(t)(2)(A)(iv) of the Code provides that section 72(t)(1) shall not apply to distributions which 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 such employee and his or her beneficiary,

Section 72(t)(4) of the Code imposes the additional limitation on distributions excepted from the 10% tax by section 72(t)(2)(A)(iv) that if the series of payments is subsequently modified (other than by reason of death or disability) before the later of (1) the close of the 5-year period beginning with the date of the first payment, and (2) the employee’s attainment of age 59½, then the taxpayer’s tax for the first taxable year in which such modification occurs shall be increased by an amount determined under regulations, equal to the tax which would have been imposed except for the section 72(t)(2)(A)(iv) exception, plus interest for the deferral period.

In the absence of regulations on section 72(t) of the Code, Notice 89-25, published on March 20, 1989, provided guidance with respect to the exception to the tax on premature distributions provided under section 72(t)(2)(A)(iv). Q&A-12 of Notice 89-25 provides three methods which could be used for determining substantially equal periodic payments for purposes of section 72(t)(2)(A)(iv) of the Code. Two of these methods involve the use of an interest rate assumption which must be an interest rate that does not exceed a reasonable interest rate on the date payments commence.

One method of determining substantially equal annual periodic payments described in Q&A-12 would be to use a method acceptable for purposes of calculating the minimum distributions required under section 401(a)(9) of the Code. For distributions to be made from an individual account, this could be accomplished by dividing the account balance as of a given date by the life expectancy (or joint life and last survivor expectancy of the account owner and beneficiary, if applicable) and this would be the amount to be distributed for the first year. The life expectancies to be used are found in Table V (one life) or Table VI (two lives) of section

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1.72-9 of the Income Tax Regulations (the “Regulations.”). Where a one-time calculation is done, the same amount would be distributed in subsequent years.

A second method described in Q&A-12 determines an annual distribution amount by amortizing the taxpayer's account balance over a number of years equal to the life expectancy of the account owner or the joint life and last survivor expectancy of the account owner and beneficiary at an interest rate that does not exceed a reasonable interest rate on the date payments commence. The resulting payment is the amount to be distributed each year. Again, the life expectancies to be used are found in Table V (one life) or Table VI (two lives) of section 1.72-9 of the Regulations.

The third method described in Q&A-12 of Notice 89-25 determines substantially equal annual payments by dividing the account balance by an annuity factor (the present value of an annuity of $1 per year beginning at the taxpayer's age attained in the first distribution year and continuing for the life of the taxpayer) with such annuity factor derived using a reasonable mortality table and using an interest rate that does not exceed a reasonable interest rate on the date payments commence. If substantially equal monthly payments are being determined, the taxpayer's account balance would be divided by an annuity factor equal to the present value of an annuity of $1 per month beginning at the taxpayer's age attained in the first distribution year and continuing for the life of the taxpayer. The annuity factor is calculated using commutation functions derived from a particular mortality table where a particular interest rate is assumed. Because an infinite number of interest rates could be assumed, the number of possible tables of commutation functions is infinite. In the example in Q&A-12 of Notice 89-25, the annuity factor is derived using commutation functions based on the UP-1984 Mortality Table where an interest rate of 8% is assumed.

The methodology you have proposed to use to determine your distributions is consistent with the third method described in Q&A-12 of Notice 89-25. The life expectancy and the interest rate used are such that they do not result in the circumvention of the requirements of sections 72(t)(2)(A)(iv) and 72(t)(4) of the Code (through the use of an unreasonable high interest rate or an unreasonable life expectancy). Accordingly, we conclude that the method you described determining periodic payments satisfies one of the methods described in Notice 89-25 and results in substantially equal periodic payments within the meaning of section 72(t)(2)(A)(iv) of the Code, and such payments will not be subject to the additional tax of section 72(t) unless the requirements of section 72(t)(4) are not met.

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This ruling is directed only to the individual that requested it. Section 6110(k)(3) of the Internal Revenue Code provides that it may not be used or cited by others as precedent.

Sincerely yours,

[signature]

Martin L. Pippins, Manager

Employee Plans Actuarial Group 2

Tax Exempt and Government Entities Division