Key Takeaways
- A single premium immediate annuity (SPIA) is purchased with a single lump-sum payment.
- You begin receiving payments from a SPIA either immediately after buying it or within one year of purchase.
- You can convert your savings into annuity income for life by converting an IRA or other savings into a SPIA.
What Is a Single Premium Immediate Annuity (SPIA)?
A 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 phase and begins paying out income either immediately or within a year after you have purchased it with a single, lump-sum payment. SPIAs are also called immediate payment annuities, income annuities and immediate annuities.
This annuity is the oldest type, dating back to the ancient Roman Empire. The word annuity actually comes from the Latin, annua, which means annual payments. Roman soldiers received lifetime annuity payments to compensate for their service in the military.
Some consider it to be the simplest and most consumer friendly annuity. But it represents only a small portion — about 10 percent — of annuities sold each year. MarketWatch writer Stan Haithcock asserts the reason for this is that brokers push more complicated annuities that pay higher commissions but that are not as good for consumers.
In 2023, total annuity sales are projected to be $354.1 billion. That’s up from $310.6 billion in 2022.
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) plans, IRAs and other popular retirement plans. SPIAs allow seniors to supplement Social Security income and pension plans, which might not provide enough to cover retirement living expenses. In fact, employees retiring can roll their 401(k) plans into a SPIA to create meaningful income over retirement.
How Immediate Annuities Work
Immediate annuities can be customized. Owners can receive payments monthly, quarterly, semiannually or annually. At the time of purchase, you and an advisor will customize your income stream. Payments can be made over one life or two lives, as guaranteed lifetime payments, and can include beneficiary protection for your heirs. Payments can also be structured over a specific period of time, such as 10 years, which is referred to as “period certain.” Each payment you receive consists of your premium plus a portion of interest earnings.
How an immediate annuity is taxed depends on how the account was funded.
The interest rate on an immediate annuity can be:
- Fixed
- Adjusted annually for inflation
- Varied with earnings, based on the performance of its subaccounts
In the case of a fixed rate, each payment to the annuity owner will be the same. If the annuity is variable, the amount of each check will be different because the subaccounts will fluctuate. Both of these options help protect payments from inflation, but fixed annuities offer more reliability than variable annuities.
SPIA interest rates are often more favorable than certificate of deposit (CD) and U.S. Department of the Treasury rates.
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Purchasing a SPIA
A person or company can purchase a SPIA from an insurance company using a lump sum. This lump sum, or premium, must be paid up front.
Your payment amount will be calculated based on the type of annuity you buy, the term of the contract, your age and sex and a number of other factors.
The type of premium you use to fund the annuity will impact how your payments are taxed. Annuities are insurance products, not investments, and the payment streams they generate are considered a form of income, so they are subject to income taxes.
If you fund your annuity with after-tax dollars, you own a non-qualified annuity. This means when you receive disbursements, a portion of every payment is considered a return of principal, which is not taxed.
The remaining portion of the payment consists of interest earnings and is taxable.
In addition, if you buy an immediate annuity in a state that levies a state premium tax on annuities, you will have to pay the premium tax at the time of purchase.
Examples of non-qualified immediate annuity funding sources include:
- Deferred compensation
- After-tax savings
- Money market accounts
- Mutual fund proceeds
- Inheritance
- Life insurance settlement
- Certificate of deposit (CD)
- Deferred annuity that was previously funded with the sources above
Conversely, if you purchase your annuity with pre-tax money, your annuity is qualified, and the entire amount of each payment will be subject to ordinary income tax rates.
Examples of qualified immediate annuity funding sources include:
- Corporate-sponsored defined contribution plans
- IRAs
- 401(k) plans
- Simplified Employee Pension (SEP) plans
- Section 403(b) tax-sheltered annuities
- Section 1035 annuity exchanges
- Annuities previously funded with the sources above
Keep in mind that SPIAs are annuitized immediately, which means your premium is instantly converted to a stream of regular payments. If that is not your goal — for instance, if you have another form of retirement income or you would prefer to have a lump of cash accessible for specific reasons — a SPIA is not the right product for you.
Case Study Example
Who might be best suited to purchasing a SPIA? Let’s look at an example of a typical SPIA customer.
“Typically, the average person that’s buying an immediate income annuity is in retirement or about to retire,” expert contributor and Certified Financial Planner™ professional Stephen Kates told Annuity.org. Like Charlotte in the example above, many retirees face the risk of running out of money once they stop working. By purchasing a SPIA, Charlotte can guarantee that she’ll receive regular income payments for as long as she lives.
Purchasing a SPIA is a trade-off; you’re giving up the liquidity of your savings for a guaranteed income stream you won’t outlive. If securing lifetime income is your top priority, then an immediate annuity could be worth losing access to those savings as a whole.
Pros and Cons of Immediate Annuities
There are advantages and disadvantages to single premium immediate annuities.
- Guaranteed and Immediate Income
- When you purchase an annuity, you transfer risk to an insurance company that, in turn, begins paying you within the first year of your contract. Fixed immediate annuities are invested in stocks and bonds through the insurance company’s general fund, and the interest rate cannot go below a certain minimum. Variable annuities offer riders that guarantee that your annuity value will not drop below a certain threshold even if the stock market declines and your subaccounts lose money.
- 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 increase your returns above those of other 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 appreciation.
- No Fees
- Immediate annuities don’t have any account management or account maintenance charges.
- Ease of Use
- Purchasers appreciate the systematic and reliable payment stream afforded by single premium immediate annuities. Once established, an immediate annuity requires no maintenance or work.
- Plan for Retirement
- Many people use single premium immediate annuities to fund their retirement. A financial advisor will be able to help you calculate the amount required to fund the income you desire. Once you know how much you’ll need, you can enter your data into our immediate annuity calculator to get an estimated monthly income figure. Many seniors prefer this reliability to the volatility of the stock market.
- COLA
- For an added cost, you can purchase a cost of living adjustment (COLA) rider for your SPIA, which will increase your annuity payments over time depending on how the rate of inflation has increased. However, it’s important to evaluate this option carefully with a financial advisor because this feature typically produces substantially lower beginning payments.
- One-Time Withdrawal
- Some insurance companies offer one-time cash advance options for annuitants who have an immediate need for cash. Otherwise, annuities cannot be changed and only pay out the set amount on the disbursement schedule.
- Option to Make SPIAs Beneficiary Friendly
- There is some misconception that SPIAs will not pay benefits to your heirs when you pass. While it is possible to elect a payment that is optimized for the highest income and contains no death benefits, referred to as life only, the majority of SPIAs sold contain death benefits. One popular option to explore with a financial advisor is “Life with Cash Refund,” where the insurance company pays the heirs any remainder of the initial deposit that was not paid to the annuitant upon death.
Pros of SPIAs
- 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. In essence, you are trading your lump sum for a guaranteed income stream. That means funds may not be available for emergencies or any other use.
- Loss of Purchasing Power
- Most insurance companies offer optional inflation benefits. If your single premium immediate annuity does not contain an inflation adjustment feature, it could mean that your payment may not be keeping pace with inflationary trends. Be sure to discuss this option with your financial advisor.
- Single Premium Immediate Variable Annuity Risk
- Most of the SPIAs purchased today are fixed SPIAs. If your single premium immediate annuity is variable, which means it contains market risk, then your payment stream could decline based on changes to the subaccounts that are invested in risk-based assets.
Cons of SPIAs
Who Shouldn’t Get a SPIA?
Annuities are not for everyone. A decision to purchase a SPIA should be carefully evaluated with the whole of your financial well-being. Because you lose control of your money, you need to be sure you have ample liquid assets in the event of an emergency. But there’s good news. Financial advisors today are required by their State Insurance Departments to undergo annuity training to help assure consumers get the information they need. As an additional layer of consumer protection, insurance companies offering annuities carefully scrutinize annuity purchases to be sure they are suitable for the purchaser.
Peace of Mind Comes From Knowing Your Money Is Protected
Minimizing Risk
Annuities are popular financial options for retirees because they offer a relatively low level of risk. Still, there is some risk involved in purchasing a SPIA.
- Diversifying Investments
- Even if you decide an immediate annuity is a good financial choice, most experts advise you to not put all of your available financial resources into a single contract, but rather maintain adequate amounts in stocks, bonds and ready cash for any emergencies or opportunities that may arise.
- Research the Insurance Company
- Research with buyers of SPIAs reveals that the carrier’s financial strength was cited as the single most important factor in purchasing a SPIA. Before purchasing your single premium immediate annuity, make sure the insurance company that issues your annuity is highly rated. Financial institution rating agencies like Moody’s, Fitch, A.M. Best, and Standard & Poor’s are all reputable places to research insurance companies.
- Check Guaranty Associations
- Before purchasing an annuity, investigate your state guaranty association. If the insurance company you purchase your annuity from fails, this association will reimburse you. Make sure you know the coverage limit, and how this limit may change should you relocate to another state.
To minimize this risk, you should consider:
How do immediate annuities pay out?
Learn how an investment today can provide guaranteed income for life.
Common Questions About Immediate Annuities
Immediate annuities are good investments for people who are close to retirement and want guaranteed income. These types of annuities are not suitable investments for people who seek wealth accumulation or capital appreciation. Immediate annuities do not offer these benefits.
Unless you have purchased a rider that allows for a beneficiary, the account balance of your immediate annuity will be distributed to other annuity holders within the pool of annuitants that have contributed premiums to the insurance company’s general account.
A qualified annuity is purchased with pre-tax dollars from a retirement account, whereas a non-qualified annuity is purchased with money that has already been taxed.
A single premium immediate annuity, or SPIA, is a great option for people who seek guaranteed periodic payments in the form of an income stream. You should buy a SPIA if you want the benefit of tax-deferral and the security of a pension-like income stream in retirement that begins within a year of your purchase.
An immediate annuity pays a fixed amount set by the insurance carrier. The insurer calculates the payment amount based on multiple factors that contribute the company’s profit margin and it never changes.
