The Truth About Distribution Calculators & Methods

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Our Federal government is famous for providing "precisely what you don't need". Well, in that vein, 72(t) computational methodologies are no exception. One can trace through all of the authorities on this issue starting with Notice 89-25, followed by Revenue Ruling 2002-62 and then most recently with Notice 2022-6.

All three primary authorities focus repeatedly on three general methodologies: the minimum method, the amortization method and the annuitization method. Further, let's make some general assumptions:

A methodology is discrete and therefore gets to be named as such whenever material differences can found in its computational characteristics or requirements; e.g. if the mathematics are different, then it must be a different methodology.
A methodology might also be considered separate or different depending on how often we need to put pencil to paper in order to get a distribution answer. In this regard there seems to be only two options: (a) once for the entire plan duration; or (b) once per year.
Lastly, this website is devoted to early distributions (meaning before the age 59 ½). As a result, we are only interested in methodologies that maximize annual distributions. Any methodologies that fail this maximum test are of little to no use to us as we can always find better ways to deploy our assets; e.g. we generally follow the concept that the lesser assets devoted to a plan in order to achieve the same annual distribution is inherently a better outcome.

With these three assumptions in mind we can quickly find six methodologies that pass assumptions (1) & (2). However, in short order, we learn that four of the six immediately fail. In summary, there are not really three methods (as found in IRS materials), there are not six as four fail; there are really only two that count in any meaningful way. With this in mind let's at least look at all six:

Minimum method recalculated annually — this method is actually borrowed from the 1970's in the original creation of IRAs. Simply put, in order to be qualified, taxpayers over the age of 70 ½ (now updated to age 72) were required to make increasing annual distributions, otherwise an IRA could technically last forever — not something in the US Treasury department's best interests. As a result the minimum method is pretty easy to implement: take your account balance as of the previous 12/31st and divide by your life expectancy (as found in tables published in IRS Publication 590B). In general, a 72 year-old has a life expectancy of 27.4 years; an 82 year-old is 18.5 years. As a result, the 72 year old must distribute almost 3.6% of their account balance or suffer the consequences of the excess accumulations tax of 50%; the 82 year old must distribute 5.4%. Not surprisingly, octogenarians don't like these rules. We don't like them either as these 1 Notice 89-25. 2 When the life expectancy tables and mortality table from which they are built became standardized starting 2003, this method died as it always yields an annual distribution amount between 98.5% and 99.5% of the amortization method. This is caused by the inherent 'mid-year" death assumption in a mortality table versus an "end of year" or arrears assumption in the amortization formula. percentages are too low to be of any material interest — a 55 year-old is only 3.2% of the account balance. So we have established that just about everyone hates the minimum method — older folk because the number gets too big; younger folk because the number is not big enough.
Minimum method calculated once per plan (or life) — this method, although it could exist, does not. For older folk it would be a god-send as IRA accounts could start to look like forever accounts. For the younger group, it just sustains its greatest deterrent — the numbers are too small.
Fixed Annuitization — this method was in full use from 1986 up to 2003 as it frequently yielded the highest annual distribution of all methods. Its used a mortality table discounting system using a "using a reasonable mortality table"¹. 30 to 40 years ago there were many mortality tables, some more aggressive than others, as well as a mix of male/female/unisex tables. This methodology died effective 1/1/2003 when Rev. Rule 2002-62 became mandatory requiring the use of only the IRS published mortality table².
Annually Recalculated Annuitization — similar to (3) above, it too died in 2003 for the same reasoning.
Fixed Amortization — this method has withstood the test of time. It is actually the same formula as used to calculate a mortgage payment. Just about all spreadsheet products: Excel, Lotus, Google Sheets, etc. have a macro command, "PMT", requiring: principal balance, interest rate, and term. Sometimes the operands are in a different sequence but all yield the same result. Further, of all of the "fixed" formulas, this methodology always yields the highest annual distribution. Further, it is actually mathematically impossible, under any circumstance, for any of the other approved methodologies to yield a higher result. As is written in both Revenue Ruling 2002-62 and Notice 2022-6, this computation, because it is fixed, is performed once for the taxpayer's plan and the same amount, as computed is distributed for all plan years. I guess we have a winner!
Annually Recalculated Amortization — this method too has withstood the tests of time with one material difference. It is recalculated once per year not unlike the minimum method. On a date, and it is the same date every year, (12/31 is a real easy date to use), the taxpayer updates all three variables (operands in the amortization formula): account balance, interest rate assumption, and a new life expectancy value from Publication 590B. This then becomes a bit of a wild card. All three of the values will potentially move every year: account balances will go up or down based on investment experience; interest rates can also move in either direction; life expectancy can only go down (usually by .9 years each calendar year). Thus, annual recalculation here presents a different set of risks and rewards which are often different depending on the facts and circumstances pertinent to an individual taxpayer.

In summary, we are really left with one formula (amortization) with two implementation strategies: FIXED (for the entire taxpayer's plan) or ANNUALLY RECALCULATED (for each and every year in the taxpayer's plan). In passing, a few taxpayers have presented the IRS (both formally using the PLR process as well informally through conversations with the IRS) with other computational methodologies, each of which appeared, at that time, to have had some merit. All have failed as the IRS has ruled against these methods evidently wanting to fix the playing field.

1 Notice 89-25.

2 When the life expectancy tables and mortality table from which they are built became standardized starting 2003, this method died as it always yields an annual distribution amount between 98.5% and 99.5% of the amortization method. This is caused by the inherent 'mid-year" death assumption in a mortality table versus an "end of year" or arrears assumption in the amortization formula.