IRS Updates Guidance on Substantially Equal Periodic Payments Exception to 10% Additional Tax

The IRS has updated its guidance regarding when payments from qualified retirement plans (including 401(k) plans, other tax-qualified plans, and IRAs) are considered substantially equal periodic payments that are not subject to the 10% additional tax on early distributions. (There are also other exceptions to the tax—e.g., for distributions after death or attaining age 59 1/2.) In Revenue Ruling 2002-62 (see our Checkpoint article), the IRS described three methods for calculating the annual amount of such payments: the required minimum distribution (RMD) method, the fixed amortization method, and the fixed annuitization method. That guidance specified the life expectancy tables that could be used to determine the distribution periods under these methods, and set certain other rules, including permissible interest rates and a one-time exception to the statutory rule that precludes modification of substantially equal periodic payments. Under that exception, individuals receiving payments calculated under the fixed amortization or fixed annuitization method may switch to the RMD method without triggering the tax, but they must follow the RMD method in all later years.

Notice 2022-6 updates and clarifies the IRS’s guidance on the substantially equal periodic payments exception, superseding both the previous guidance for qualified retirement plans and guidance that applied the same requirements to non-qualified annuity contracts. Here are highlights of the changes affecting qualified retirement plans:

• Permissible Distribution Methods. The three distribution methods described in the previous guidance are largely unchanged, but some of the requirements have been clarified. For example, the description of the RMD method specifies when use of a different life expectancy—including a change in life expectancy table—is not a prohibited modification, and the fixed annuitization method now references mortality rates in the regulations instead of a mortality table that previously appeared as an appendix.
• Life Expectancy Tables. The life expectancy tables that can be used to determine substantially equal payments have been updated. References to the single life expectancy and joint and last survivor tables now cite the 2020 amended versions of those tables in the RMD regulations (see our Checkpoint article). And the uniform lifetime table included as Appendix A reflects the generally longer life expectancies in the 2020 regulations. [EBIA Comment: The uniform lifetime table in the 2020 regulations begins at age 72; Appendix A incorporates that table but begins it at age 10.]
• Interest Rates. A 5% floor has been added to the maximum interest rate that can be used when applying the fixed amortization or fixed annuitization method. As revised, the maximum is the greater of 5% or 120% of the federal mid-term rate.
• Other Changes. A safe harbor method can be used to determine the account balance when applying the fixed amortization and fixed annuitization methods. The guidance also appears to tighten the rule regarding modifications triggered by transfers or rollovers, and explains that, in the context of IRA distributions, the term “employee” includes an IRA owner.
• One-Time Change Exception. There are no significant changes to the exception allowing a one-time change from the fixed amortization or fixed annuitization method to the RMD method.

While this notice replaces the earlier guidance for any series of payments commencing on or after January 1, 2023, it can be used for a series of payments commencing in 2022. Payments calculated using the RMD method that began prior to 2023 will not violate the no-modifications rule (and thus will not trigger the additional tax) if one of the new tables is used.

EBIA Comment: The exception for substantially equal periodic payments is unavailable for distributions from a 401(k) plan (or other qualified plan) before the participant terminates employment. This limitation, along with the burden of administering periodic payments and the fact that Code § 72(t) waives the 10% additional tax for post-employment distributions to participants who separate from service after attaining age 55, has led many qualified plan sponsors to decide not to allow periodic payments. Plans that do not permit periodic payments will not be affected by the guidance. For plans that include the feature, however, as well as for individuals with IRAs and non-qualified annuities, these changes are potentially important. For more information, see EBIA’s 401(k) Plans manual at Sections XII.I (“Required Minimum Distributions”) and XIV.K (“10% Additional Tax on Early Distributions”).

Contributing Authors: EBIA Staff.