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72(q) & 72(t) Distributions
(t = qualified funds; q = non-qualified)

To discourage investors from accessing non-qualified annuity funds before retirement, distributions are generally subject to an IRS 10% early withdrawal penalty if a distribution is made from the annuity before age 59.5. However, there are several exceptions allowed through IRC Section 72(q)/72(t) where the penalty can be avoided. One such exception makes it possible to access retirement assets IRS penalty-free at any age, by receiving income as a series of substantially equal periodic payments.

Substantially Equal Periodic Payments
This is a way of receiving an income stream based on the owner's life expectancy. A complete assessment of the client's financial situation should be performed and other sources of income should be exhausted before considering an IRC Section 72(q)/72(t) distribution. In addition, there are several other important considerations to review with your client when contemplating this option:
Payment Methods
There are three acceptable methods of calculating 72(q)/72(t) distributions:

  1. Life Expectancy Method
    • Calculated by dividing the annuity account balance by a life expectancy factor that is published in the IRS tables
    • Payment amounts must be recalculated annually
    • Since payments are recalculated based on life expectancy, the payment amount will vary from year to year. Generally, this method provides for smaller payments in the beginning, with payments increasing annually over time.
  2. Amortization Method
    • Calculated by amortizing the annuity account balance over the life expectancy of an individual, or the joint life expectancy of an individual and designated beneficiary, by using IRS mortality table and reasonable interest rate.*
    • Payments are NOT recalculated annually and remain constant over time
  3. Annuitization Method
    • Calculated by dividing the annuiy account balance by an annuity factor that is published in the IRS mortality tables and a reasonable interest rate.*
    • This method does NOT require annuitization of the contract
    • Payments are not recalculated annually and remain constant over time
A tax advisor should carefully consider the initial funding amount, payment method (including interest rate assumption), payment frequency, and investment options. Investment performance should be monitored and periodically adjusted as necessary to ensure assets are sufficient to continue the specified IRS Section 72(q)/72(t) payment amount.

In addition, any 72(q)/72(t) distribution payment over the free withdrawal provisions of the specified contract will be subject to surrender charges and applicable market value adjustment.

*IRC Section 72(q)/72(t) Distribution Interest Rate
IRS general information letter (INFO 200-0226) states that the interest rate used for 72(q)/72(t) distribution calculations must be a "reasonable interest rate" equivalent to 120% of the Federal Mid-Term Rate. Your client should consult with his/her tax advisor to determine the assumed interest rate to use. 

Last Updated: 9/23/2012 10:05:00 PM