IRS Allows One-Time RMD-Method Change

In Rev. Rul. 2002-62, the Service modified Notice 89-25, Q&A-12, to allow taxpayers who chose a fixed annuitization or a fixed amortization method to calculate their substantially equal periodic payments, to change to the required minimum distribution (RMD) method, without incurring a penalty.

Generally, taxpayers pay a 10% penalty on withdrawals from an IRA or employer-sponsored individual account plan taken before reaching age 59¹/2, unless they take substantially equal periodic distributions over their life expectancy or a joint-life expectancy with the beneficiary. Those who chose annuitization or amortization (which requires a fixed annual withdrawal) have to pay a retroactive penalty on all distributions, if they wanted to reduce the amount received to keep their account from being dissipated.

Under the ruling, taxpayers can change to the RMD method without incurring that penalty. A taxpayer can compute the distribution every year based on the current account balance and life expectancy. Once taxpayers change to the RMD method, however, they must follow that method in all subsequent years. Any other change is treated as a modification under Sec. 72(t)(4), resulting in a penalty.

Rev. Rul. 2002-62 also (1) clarifies how a taxpayer can meet the permitted method that tracks the Sec. 401(a)(9) RMD rules, in light of the final regulations; (2) provides guidance on a reasonable interest rate for determining payments to satisfy the substantially equal periodic-payment rule; and (3) provides a choice of mortality tables to be used in satisfying the permitted methods. It also clarifies that the penalty will not apply for failing to take a withdrawal when the account assets are fully dissipated.

The ruling applies to any series of payments commencing after 2002, and may be used for 2002 distributions. If payments meeting Sec. 72(t)(2)(A)(iv) started before 2003, the calculation method could be changed at any time to the RMD method, including the use of a different life expectancy table.

Even though this change will aid some taxpayers in offsetting deep portfolio losses and preserving their capital, it might harm others if the underlying asset value significantly increases, raising the mandatory withdrawal amount. Taxpayers should weigh the effect of switching methods, based on account balance, age, distribution start date, calculation interest rate and single versus joint-and-survivor life expectancy, before deciding to change.

From Sylvia J. Pozarnsky, Chicago, IL