What Is the Term Certain Method?
The term certain method is a way to calculate the amount of money that should be taken from a retirement account or annuity each year based on the account owner's life expectancy.
This method is used to determine the amount to be paid to investors who purchase a term certain (or 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 defined time frame rather than the lifespan of the annuitant.
- The term certain method calculates the amount of installment payments from a retirement account or annuity in order to make it last for the account owner's expected lifetime.
- A policyholder receives term certain annuity payments for that period of time.
- A term certain annuity is subject to annual review in case adjustments need to be made to the 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 is steadily depleted, while the person's life expectancy decreases by one year. The retirement account will be completely depleted when the account holder reaches their life expectancy age.
If the person defies the statistics and keeps 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 and live well past projected life expectancy.
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 73 as of Jan. 1, 2023. (For many years, the required age was 70-1/2, but that was raised to 72 with the passage of the SECURE Act in December 2019. The age was raised again to 73 in 2022.)
Required minimum distributions for traditional IRAs and 401(k)s were suspended in 2020 due to the coronavirus pandemic, but unlike many other coronavirus-related measures it was not extended beyond that year. That means people aged 73 and over are again required to take their RMDs.
Using the Term Certain Method
Determining the life expectancy of the individual is key, according to the site 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, barring a serious health issue or some other emergency.
What's good about the term certain method is that it guarantees consistent distributions each year, the site noted. That can be a comfort to people in excellent health who are looking forward to many more years of life.
The term certain method is particularly meaningful "when coupled with other resources such as savings, investments, and other assets," the site noted.
Can I Choose How My Annuity Is Paid Out?
Yes, there are a number of decisions to make when considering an annuity. Among them is whether to take a fixed amount or a fixed term (also called term certain) payment.
- A fixed-amount annuity allows the annuity holder to choose the amount of money to be paid out each month. The payments continue until the account is exhausted.
- A fixed term or term certain annuity calculates the monthly payment based on the annuity holder's estimated life span. If the account holder passes away before the term ends, the payments go to an heir or heirs.
There are many variations. A couple, for example, may arrange a schedule that continues payments to the surviving spouse.
Should I Use the Term Certain Method for My Retirement Account Withdrawals?
Actually, you're pretty much forced to use the term certain method to make withdrawals from your retirement accounts in order to satisfy tax regulations. Owners of tax-advantaged retirement accounts such as traditional IRAs and traditional 401(k) plans must begin withdrawing a minimum amount each year beginning at age 73. The process of reporting this transaction includes an IRS worksheet that uses the term certain method to arrive at the amount that must be withdrawn.
Of course, you might take money out earlier, or take more out than the required withdrawals. The worksheet will give you a sense of how much it's prudent to take out from year to year.
Is an Annuity a Good Choice for Retirement Savings?
Saving towards an annuity is one choice for people choosing how to save towards retirement. It can guarantee a steady stream of income. That is, after all the goal of any retirement plan.
You should look carefully first at the many types of annuities that are available. Then look hard at the plans that are available, considering fees, charges, and everything else in the fine print.
The Bottom Line
There's a kind of grim reality behind the term certain method. It requires you to consider how much money you need each month based on how many years you're expected to live.
Nonetheless, it's a necessary exercise in retirement and estate planning. In fact, you have to go through the term certain calculation in order to determine how much money you're legally required to withdraw from your tax-advantaged accounts each year during your retirement.