What Is the Fixed Annuitization Method?
The term fixed annuitization method refers to one of three methods by which early retirees of any age can access their retirement funds without penalty before turning 59½. The fixed annuitization method divides the retiree's account balance by an annuity factor taken from IRS tables to determine an annual payment amount. The annuity factor is based on mortality tables and an interest rate set by the Internal Revenue Service (IRS). The payment amount cannot be changed.
- Withdrawals from retirement accounts before the age of 59½ normally come with early withdrawal penalties.
- People who retire before 59½ can use the fixed annuitization method to access their account funds without early withdrawal penalties. before 59½ to access their retirement accounts without incurring an early withdrawal penalty.
- The fixed annuitization method determines an annual payment amount by an annuity factor using IRS tables.
- The annuity factor is based on IRS mortality tables and an interest rate of no more than the greater of 5% or 120% of the federal mid-term rate.
- Early retirees may also choose from the fixed amortization method or the required minimum distribution method for penalty-free withdrawals.
How the Fixed Annuitization Method Works
Retirement accounts are designed to help you save money for the point at which you decide to permanently leave the workplace. There are a number of options available, including traditional and Roth 401(k)s, traditional and Roth individual retirement accounts (IRAs), and others. The one(s) you choose depends entirely on your budget, personal situation, and goals.
Since these accounts are designed for a specific purpose, there are rules surrounding how you can use them. This includes restrictions on withdrawals. You are generally allowed to start withdrawing money from these accounts when you turn 59½ without incurring an early withdrawal fee. Keep in mind, though, that you may have to pay taxes on withdrawals made after that age from certain accounts.
But what happens if you take early retirement? There may be a way for you to access your retirement nest egg without incurring any penalties before you reach the magic age of 59½. You can do this using the fixed annuitization method. Also called 72(t) distributions or Substantially Equal Periodic Payments (SEPP), this manoeuver breaks up a retirement account balance by using an annuity factor. Tables set out by the IRS are used to determine the annual payment amount and an interest rate that is no more than the greater of 5% or 120% of the federal mid-term rate. As mentioned above, the payment remains as such and cannot be changed once it is set.
The fixed annuitization method is complicated but sometimes offers the highest payments.
Funds withdrawn before age 59½ are typically assessed a 10% early withdrawal penalty. Funds must be withdrawn as substantially equal periodic payments as outlined by Internal Revenue Code (IRC) Section 72(t). They must continue for five years or until the retiree reaches 59½, whichever is longer.
Retirees can elect to receive their distributions annually, quarterly, or monthly. If withdrawals are stopped, all funds that have already been withdrawn become subject to early withdrawal penalties.
Other Calculation Methods
There are two other ways that retirees can use if they end up retiring early without incurring early withdrawal penalties. These are the fixed amortization method and the required minimum distribution (RMD) method.
Deciding which method to use can be complicated and each can result in quite different distribution amounts. That's why it's wise to get professional advice when seeking to take an early distribution.
Fixed Amortization Method
The fixed amortization method also uses remaining life expectancies determined by the IRS' tables at an interest rate that is no more than the greater of 5% or 120% of the federal mid-term rate. One difference between this and the fixed annuitization method is that the amount can't be changed once it's calculated until the retiree turns 65. If it is changed, the account holder incurs a 10% penalty each year. Interest charges also apply. These fees are charged as of the year the distributions are paid out.
Required Minimum Distribution Method
The required minimum distribution (RMD) or mandatory distribution method is the way that most retirement accounts require account holders to use their balances. This is the minimum amount of money that must be taken out each year to avoid incurring any penalties or fines.
The rules surrounding RMDs have changed several times. The age for taking RMDs was 70½ until the Setting Every Community Up For Retirement Enhancement (SECURE) Act was passed in December 2019. Retirees were required to begin taking their mandatory withdrawals as of April 1 the year after they turned 72. The age was raised again following the passage of the SECURE Act 2.0 in December 2022. Anyone who turns 73 on or after Jan. 1, 2023, must begin taking RMDs as of April 1 of the following year.
According to the IRS, the RMD method consists of an account balance and a life expectancy. Life expectancy is divided into different categories, including:
- Single Life: This category is meant for beneficiaries whose spouses don't have IRA accounts.
- Uniform Life: This category includes IRA owners who are unmarried and determining their own withdrawals. It also includes IRA owners who are married to spouses who are less than 10 years younger than them. Married IRA owners whose spouses aren’t the sole beneficiaries of their IRAs are also included.
- Joint Life and Last Survivor: This category is made up of IRA account holders whose spouses are more than 10 years younger than them and are the sole beneficiaries of the account.
Each of these uses attained age(s) in the distribution calculation year. The annual payment is redetermined each year.