Single Premium Annuities
Single-premium annuities are purchased with a lump sum of money, and offer a guaranteed source of income for retirement. They can be immediate or deferred, but once purchased, can’t be returned, and surrender fees are steep.
An immediate annuity, also known as an income or single premium immediate annuity (SPIA), is a contract between you and an insurance company designed for income purposes only. Unlike a deferred annuity, an immediate annuity skips the accumulation stage and begins paying out income either immediately or within a year after you have purchased it with a single, lump-sum investment.
Individuals approaching retirement age may choose this type of annuity because they will be able to make large contributions without the limitations of 401(k)s, IRAs and other popular retirement plans. Single premium immediate annuities allow seniors to supplement Social Security income and pension plans, which might not provide enough to cover retirement living expenses.
How Immediate Annuities Work
Immediate annuities can provide periodic payments for a fixed period of time or for the rest of your or your spouse's life, depending on which option you choose. Distributions may be received monthly, quarterly or yearly, and will consist of a combination of your account's principal and any earnings it has accrued.
If the immediate annuity is nonqualified, meaning you have purchased it with after-tax dollars, only the earnings will subject to income tax, which you must pay each year at your ordinary rate.
Similar to a deferred annuity, the interest rate on an immediate annuity can be fixed, adjusted annually according to an outside index, or variable with earnings based on the performance of its subaccounts. If it has a fixed rate, each of your distribution checks will be the same. If the annuity is variable, the amount of each check will differ. These options help protect payments from inflation rates.
Unlike a structured settlement, the payments from an immediate annuity can be sold for cash without going through the hassle of going to court for a judge's approval. Because you purchase this investment product on your own — rather than accepting it as a result of a lawsuit — you have the freedom to sell payments for cash if you're experiencing financial difficulty.
The advantages of an immediate annuity are certain guarantees that protect the principal you invested and the benefits contingent upon the annuitant's age. These advantages include:
- Safety: As with any annuity, your risk can be transferred to the insurance company. If the immediate annuity is fixed, your premium goes into the company's general fund to be invested in bonds and stocks, and the interest rate cannot go below a certain minimum. If the immediate annuity is variable, you can purchase a rider that guarantees your annuity account will not dip below a certain threshold even if your subaccounts lose money.
- Tax-deferred Growth: The income payments for immediate annuities are based on a combination of principal returns, which are not taxed, and payout of income, which is taxed at income tax rates rather than capital-gain rates. This enables you to pay lower investment taxes and spread your payment over time.
- Mortality Credits: Risk pooling, or the spreading of risk across many accounts, allows premiums from annuity owners who die prematurely to be used to pay benefits for those who live beyond their life expectancy. These mortality credits can help increase your returns above those of other investment options and, by choosing a lifetime benefit option, you can hedge against ever outliving your available assets. In fact, depending upon how long you live, your annuity can actually pay you more money than you originally invested plus what your account has earned in interest or capital gains.
While an immediate annuity can provide a consistent income stream in your retirement years, there are drawbacks. Purchasing immediate annuities can prevent you from being able to afford other investments. Here is a description of these disadvantages:
- Loss of Control: The most significant drawback is that immediate annuities are irrevocable. Once your lump-sum payment has been exchanged for periodic distributions, you no longer have control or access to your money. That means funds may not be available for emergencies or any other use.
- Loss of Purchasing Power: If your annuity has a fixed rate of interest that is lower than the rate of inflation, your money is not working for your benefit.
- Expense: All annuities carry fees, commissions and administrative charges that are usually higher than those that accompany other investments.
- Risk: If your immediate annuity is variable, then your principal is at risk unless you purchase a guarantee against loss.
Total annuity sales in the U.S. soared to $167.6 billion in Q3 2013. In that same time period, fixed immediate annuity sales alone reached $5.7 billion. But even if you decide that an immediate annuity is a good investment choice, most experts advise you to not put all of your available assets into one, but rather leave enough in stocks, bonds and ready cash for unexpected needs.
Also, you should make sure the insurance company that issues your annuity is highly rated by any of the financial institution rating agencies like Moody's, Fitch, Standard & Poor's or A.M. Best.