What is the ‘Term Certain Method’
The term certain method refers to a way to calculate minimum distributions from a retirement account based on the account holder’s life expectancy. According to the term certain method, the distribution or withdrawal from the retirement account is based on the holder’s life expectancy at the time of the first withdrawal. With each successive year, the account gets steadily depleted as life expectancy reduces by one year. The retirement account would thus be completely depleted once the account holder reaches his or her life expectancy age.
BREAKING DOWN ‘Term Certain Method’
With the term certain method, owners of individual retirement accounts are required to commence minimum withdrawals from their IRA on or before April 1 in the year after the year in which they reach the age of 70 1/2.
In other words, as Zacks explains, the method’s calculation is based a person’s life expectancy at the time of the first distribution. “As the amount is withdrawn each year, the account’s balance steadily decreases until, theoretically, the balance equals zero when your life ends.”
The obvious challenge with the term certain method is that a healthy retiree may outlive his or her retirement savings if he or she lives well past projected life expectancy.
A term certain annuity usually involves bigger payouts each month than a life annuity or an immediate annuity, for instance, given that it covers a specific time frame, rather than having to cover the entire lifespan of the annuitant.
Determining Life Expectancy with Term Certain Method
“Key to the application of the term certain method is to determine the life expectancy of the individual,” according to WiseGEEK. “Generally, the first year of distribution in a term certain method is based on the current life expectancy determined for the individual. Each successive year, the life expectancy is adjusted to allow for various factors, including a change in the cumulative number of years that the individual is expected to live.
“This process of annual review sometimes results in a change in the distribution amount for the upcoming calendar year, although the difference is usually small,” the website explains. “The exception would be in the event of some drastic change in general health or some other factor that would significantly change the projected life expectancy.”
One benefit of the term certain method is that “distributions of some size will continue to be made every year.” according to the site. “This can be a comfort for people who are in excellent health at the time of retirement, and can look forward to living two to three decades after retiring. When coupled with other resources such as savings, investments, and other assets, the retirement plan that makes use of a term certain method for annual distributions can provide a sense of security that allows people to truly enjoy the years after active employment in the workplace.”