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The annuity factor method is a way to determine how much money can be withdrawn early from retirement accounts before incurring penalties.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 (IRA). It is similar to the fixed amortization method, though it utilizes somewhat different data.

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.

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.

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:

• 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

Additionally, examples of the mathematical formula for calculating the present value annuity factor can be found here and here.