What Is the Life Expectancy Method?
The life expectancy method is a way of calculating individual retirement account (IRA) distribution payments by dividing the balance or total value of a retirement account by the policyholder’s anticipated length of life. The life expectancy method is the most straightforward method of calculating required minimum distributions (RMDs) for retirement accounts by the Internal Revenue Service (IRS).
RMDs are required distributions that must be withdrawn from certain retirement accounts once the owner reaches age 72. Please note that the IRS has suspended RMDs for retirement accounts, including IRAs and 401(k)s for 2020.
On March 27, 2020, President Trump signed a $2 trillion coronavirus emergency stimulus package, called the CARES Act (Coronavirus Aid, Relief, and Economic Security Act), into law. It suspended the 2020 required minimum distributions for those 72 and older, allowing retirement accounts more time to recover from the recent stock market downturns.
- The life expectancy method is the primary way of figuring out your RMD amounts.
- RMDs are required distributions that must be withdrawn from certain retirement accounts once the owner reaches age 72. (Note that RMDs were suspended for 2020.)
- The life expectancy method takes into account your actuarial life expectancy and the starting account balance.
Understanding the Life Expectancy Method
The life expectancy method is used to calculate RMDs from traditional IRAs or qualified retirement accounts, such as 401(k) plans. The minimum withdrawal amounts must be taken from these accounts starting at age 72.
This method uses IRS life expectancy factors along with the value of your IRA in the year of distribution before that year’s withdrawal. This is, therefore, a variable method, and if your IRA value increases or decreases, the year’s distribution amount will increase or decrease accordingly. This is also the case when it comes to your life expectancy.
IRS actuarial tables help determine the life expectancy of the owner or the joint life expectancies of the owner and a beneficiary.
Types of Life Expectancy Methods
There are two types of life expectancy methods: the term-certain method and the recalculation method.
In the term-certain method, distribution or withdrawal from the retirement account is based on your life expectancy at the time of the first withdrawal. With each following year, the account is steadily depleted as life expectancy reduces by one year. The retirement account will eventually be empty once you reach your life-expectancy age. Thus, some people may completely run through their funds if they outlive their life expectancy.
To offset the risk of outliving annuity payments, some choose the recalculation method, which differs from the term-certain method by recalculating your life expectancy every year. In this case, you are withdrawing as little as possible from your account. However, if your beneficiary dies prematurely, you would have to refigure withdrawals based on your life expectancy alone.
Example of the Life Expectancy Method
Let’s look at the case of a 54-year-old single woman who chooses the term-certain method of life expectancy withdrawals. In this scenario, if the woman wants to begin receiving IRA distributions in 2021, she must first calculate the total account value as of Dec. 31, 2020, as well as her life expectancy according to IRS Publication 590 Appendix C. If the account value were $100,000 and her life expectancy is 30.5 years, the amount she can receive in distributions each year is $3,278.69.
The following year, the now 55-year-old would again take note of the account balance on Dec. 31 and divide the amount by 29.6, her new life expectancy. Essentially, the older she becomes, the shorter her life expectancy becomes, although this relationship is not linear.