Annuity Factor Method
The annuity factor method is a way to determine how much money can be withdrawn early from retirement accounts before incurring penalties. The fixed annuitization method divides the retiree's account balance by an annuity factor to determine an annual payment sum. The annuity factor is based on IRS mortality tables and the interest rate will not exceed 120% of the federal mid-term rate. Publication 1457 includes the following sections: Single Life Factors: Table S Last-to-Die Remainder Factors: Table R(2) 0.2%–4%; 4.2%–8%; 8.2%–12%; 12.2%–16%; 16.2%–20% Term Certain Factors: Table B Commutation Factors: Table H Annuity Adjustment Factors: Table K Mortality Table: Table 2000CM Several IRS publications and actuarial tables may be helpful in applying the annuity factor method and retirement account withdrawals, such as Publication 1457, which provides examples for valuing annuities, life estates, and remainders generally. The fixed amortization method amortizes a retiree's account balance over their remaining life expectancy (based on IRS tables) at an interest rate not exceeding 120% of the federal mid-term rate.
What Is the Annuity Factor Method?
The annuity factor method is a way to determine how much money can be withdrawn early from retirement accounts before incurring penalties. The calculation primarily uses life-expectancy data and is applied to annuities and individual retirement accounts (IRAs). It is similar to the fixed amortization method, though it utilizes somewhat different data.
How the Annuity Factor Method Works
Using the annuity factor method, a retirement-account holder would divide the current IRA or annuity account balance by an "annuity factor." The annuity factor is calculated based on average mortality rates (using the Internal Revenue Service (IRS) mortality table in Appendix B of IRS Revenue Ruling 2002-62) and "reasonable" interest rates — up to 120% of the mid-term Applicable Federal Rate for the month of the valuation.
Using the annuity factor method, an investor can ensure that they do not lose account value to potentially costly penalties from an early withdrawal. It can also help an account holder determine how much money they may need to raise through other means (such as by securing a loan) in addition to withdrawing money from their retirement savings account to meet their current financial needs.
Annuity Factor Method Resources
Withdrawing money from a retirement savings plan should be a careful decision as it gives the account holder less time to recoup value and earn interest on plan assets.
Several IRS publications and actuarial tables may be helpful in applying the annuity factor method and retirement account withdrawals, such as Publication 1457, which provides examples for valuing annuities, life estates, and remainders generally. Publication 1457 includes the following sections:
Annuity Factor Method vs. Other Methods
The fixed amortization method amortizes a retiree's account balance over their remaining life expectancy (based on IRS tables) at an interest rate not exceeding 120% of the federal mid-term rate.
The fixed annuitization method divides the retiree's account balance by an annuity factor to determine an annual payment sum.
The annuity factor is based on IRS mortality tables and the interest rate will not exceed 120% of the federal mid-term rate. Once the payment amount is determined, it cannot be changed. The required minimum distribution method divides the retirement account balance on Dec. 31 of the prior year by the retiree's remaining life expectancy (based on IRS tables). As such, an increase in the retiree's account balance will mean larger distributions and a decrease will lead to smaller distributions.
Related terms:
Annuities: Insurance for Retirement
An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees. read more
Applicable Federal Rate (AFR)
The applicable federal rate (AFR) is the minimum interest rate that the Internal Revenue Service (IRS) allows for private loans. read more
Fixed Amortization Method
The fixed amortization method spreads retirees’ account balances over their respective remaining life expectancies, as estimated by IRS tables. read more
Fixed Annuitization Method
The Fixed Annuitization Method is one of three methods that retirees of any age can use to access their retirement funds without penalty before turning 59½. read more
Individual Retirement Account (IRA)
An individual retirement account (IRA) is a savings plan with tax advantages that individuals can use to invest for retirement. read more
Mandatory Distribution
A mandatory distribution, or required minimum distribution (RMD), is the amount you must withdraw from certain retirement accounts each year. read more
Mortality Table
A mortality table shows the rate of deaths occurring in a defined population during a selected time interval or survival from birth to any given age. read more
Required Minimum Distribution (RMD)
A required minimum distribution is a specific amount of money a retiree must withdraw from a tax-deferred retirement account each year after age 72. read more
Rule 72(t)
Rule 72(t), issued by the Internal Revenue Service, allows for penalty-free withdrawals from an IRA account and other specified tax-advantaged accounts. read more
Substantially Equal Periodic Payment (SEPP)
A Substantially Equal Periodic Payment plan allows individuals with qualified retirement plans to withdraw funds before the age of 59 1/2 without penalties. read more