What Is the Term Certain Method?

The term certain method is a way to calculate minimum distributions that should be taken from a retirement account each year based on the account owner's life expectancy.

Its primary use is in determining the amounts to be paid to investors who purchase a term certain (period certain)annuity. A term certain annuity usually guarantees a bigger payout each month than a life annuity or an immediate annuity, because it covers a specified time frame rather than the lifespan of the annuitant.

Key Takeaways

  • The term certain method figures out how long a retirement account or annuity needs to stretch during the account owner's lifetime. 
  • A policyholder receives term certain annuity payments within their lifespan.
  • A term certain annuity is subject to annual reviews, in case adjustments need to be made to the annuity payout amounts.

How the Term Certain Method Works

Using the term certain method, the distribution or withdrawal from a retirement account is based on the holder's life expectancy at the time of the first withdrawal. With each successive year, the account gets steadily depleted as the person's life expectancy decreases by one year. The retirement account will be completely depleted when the account holder reaches his or her life expectancy age. If you defy the statistics and keep right on living, that's good news and bad news.

With a term certain annuity, otherwise known as a year's certain annuity or annuity certain, the policyholder receives payments in regular installments for a period of time. Once the prescribed period is over, the payments stop.

The obvious challenge with the term certain method is that a healthy retiree may outlive their retirement savings if they live well past projected life expectancy.

Special Considerations

The IRS uses a version of the term certain method in its worksheet for taxpayers to determine the amount of the required minimum distribution (RMD) that they must withdraw from a tax-deferred retirement account beginning at a certain age. That age is 72 for the tax year 2020. For many years, the required age was 70-1/2, but that was raised to 72 following the passage of the SECURE Act in December 2019.

Required minimum distributions for traditional IRAs and 401(k)s were suspended in 2020 due to the March 2020 passage of the CARES Act, a $2 trillion stimulus enacted amid the economic fallout from the COVID-19 pandemic. However, the 2020 waiver hasn’t been extended in 2021, meaning people who are 72 or older in 2021 must take their required minimum distributions.

Using the Term Certain Method

Determining the life expectancy of the individual is key, according to wisegeek. The first year is based on the current life expectancy of the policyholder, while each successive year sees the life expectancy adjusted to allow for a variety of factors. Distribution amounts may change for each year, but the difference is usually small, with the exception of a drastic health issue or some other emergency.

What's good about the term certain method is consistent distributions each year, the site noted, which can be a comfort to people in excellent health who are looking forward to several more decades of life. The term certain method is particularly meaningful "when coupled with other resources such as savings, investments, and other assets," the site noted.