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 annuity.

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 have been 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.

Key Takeaways

  • The term certain method calculates how long a retirement account 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 years 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.

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.

Using the Term Certain Method

"Key to the application of the term certain method is to determine the life expectancy of the individual," according to WiseGEEK. "Generally, the first year of distribution in a term certain method is based on the current life expectancy determined for the individual. Each successive year, the life expectancy is adjusted to allow for various factors, including a change in the cumulative number of years that the individual is expected to live.

"This process of annual review sometimes results in a change in the distribution amount for the upcoming calendar year, although the difference is usually small," the website explains. "The exception would be in the event of some drastic change in general health or some other factor that would significantly change the projected life expectancy."

One benefit of the term certain method is that "distributions of some size will continue to be made every year." according to the site. "This can be a comfort for people who are in excellent health at the time of retirement and can look forward to living two to three decades after retiring. When coupled with other resources such as savings, investments, and other assets, the retirement plan that makes use of a term certain method for annual distributions can provide a sense of security that allows people to truly enjoy the years after active employment in the workplace."