You probably already know taking a distribution from your self-directed IRA before you reach retirement will generally trigger a 10% early withdrawal fee, in addition to any taxes that may be due. You may also be familiar with certain exceptions that allow you to make penalty free withdrawals, including those for certain medical expenses, educational expenses, or a down payment for first-time home purchase.
But there is also another, lesser-known provision that you have available, known as a series of substantially equal payments. While it is somewhat more complicated than the other exceptions, and requires a longer term financial commitment, it might be suitable for some individuals in particular circumstances.
This exception allows you to set up a program where you begin taking annual withdrawals from your self-directed IRA prior to reaching age 59 1/2. The schedule of payments can be calculated by either a fixed annuitization method or a fixed amortization method, or the more familiar required minimum distributions method.
Fixed Annuitization. The fixed annuitization method provides the starting account balance by a factor taken from the IRS tables, which is based on mortality rates and a “reasonable” interest rate that cannot be less than 120% of the federal midterm rate. Essentially this method calculates the present value of a $1 per year lifetime annuity of a particular amount for the account holder, and divides this amount by the account balance to determine the annual payout.
Fixed Amortization. This method simply amortizes your account balance over your life expectancy. In general, the fixed amortization method yields a lower annual payment than the fixed annuitization method. When determining the “life expectancy” in the fixed amortization method, the account holder can either choose the calculation based on their life, or the joint life expectancy of themselves and their primary beneficiary.
It’s important to note that once this amount is calculated, it will not change. This means that an account that suffers significant investment losses may be depleted early, while an account that performs particularly well might have a surplus of funds.
Required Minimum Distributions. The third method of setting a schedule of substantially equal payments is to use the required minimum distributions method that applies to traditional self-directed IRA holders once they reach age 70 1/2. The biggest difference between this method and the fixed amortization and fixed annuitization methods discussed above is that the required minimum distributions are recalculated every year based on your current account balance.
You are allowed to change between these methods one time during the course of your life.
Once you begin taking substantially equal periodic payments from your self-directed IRA, you must continue to do so for at least five full years, or until you reach age 59 1/2, whichever is later. Therefore, this is not a one-time decision, and not a step to be taken lightly. It might be appropriate for your individual situation, but make sure you understand all the implications before moving forward.