Single Premium Immediate Annuities
Single premium immediate annuities (SPIAs) are purchased with a lump sum of money and offer a guaranteed source of income for retirement.
What is a Single Premium Immediate Annuity?
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 payment.
In Q2 2016, total U.S. annuity sales reached $112 billion.
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. SPIAs 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 be highly tailored; owners can receive payments monthly, quarterly or yearly, and they can receive payments for a short period of time or decades, potentially past the owner’s death. Payments will consist of the account principle — the money the owner put into the account — plus any interest earnings that may have accrued over time.
How an immediate annuity is taxed depends on how the money was put into the account.
The interest rate on an immediate annuity can be:
- Adjusted annually according to an outside index
- Varied with earnings, based on the performance of its sub-accounts
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 differ. Both of these options help protect payments from inflation rates, 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.
Purchasing a SPIA Annuity
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.
The type of premium you use to fund the annuity will impact the amount you receive in payments. Annuities are considered a form of income, so they are potentially subjected to income taxes.
If you purchase an annuity using money that has already been subject to income tax, you own a nonqualified annuity. This means when you receive disbursements, you will only pay taxes on the part of your payment that came from accumulated interest. Examples of nonqualified immediate annuity funding sources include:
- Deferred compensation
- After-tax savings
- Money market accounts
- Mutual fund proceeds
- Life insurance settlement
- Certificate of deposit (CD)
Conversely, if you purchase your annuity with pre-tax money, your annuity is qualified, and the entirety of disbursements will be subject to income tax. Examples of qualified immediate annuity funding sources include:
- Corporate-sponsored defined contribution plans
- Personal IRA
- Simplified Employee Pension Plan
- Section 403(b) sheltered annuity
- Section 1035 annuity exchange
Can You Sell A Single Premium Annuity?
Yes, you can sell your single premium immediate annuity. 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 purchased 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.
Pros and Cons of Immediate Annuities
As with any financial investment, there are benefits and drawbacks to single premium immediate annuities.
Pros of SPIAs
- Guaranteed Income – When you purchase an annuity, you transfer risk to the insurance company. 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 your annuity account will not dip below a certain threshold even if the stock market does poorly and your sub-accounts 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.
- No Fees – Immediate annuities don’t have any account management or account maintenance charges.
- Ease of Use – Once established, an immediate annuity requires no maintenance or work.
- Plan for Retirement – Many people use single premium immediate annuities to fund their retirement. It is easy to calculate how much savings you will need to purchase an annuity and guarantee monthly income or life. Many seniors prefer this reliability to the flux 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.
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.
Cons 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. That means funds may not be available for emergencies or any other use. You will only regain control of your money if you choose to sell your right to future annuity payments.
- 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.
- Variable Annuity Risk – If your immediate annuity is variable, then your principal is at risk unless you purchase a guarantee against loss.
- Costly Death Benefit – Unless an annuitant names a beneficiary, the remainder of an annuity goes to the insurance company upon an annuitant’s death. To name a beneficiary, the annuitant much purchase a death benefit, which can be costly.
- Insurance Company Failure – While there are regulations in place to protect your money, there is a small chance you could lose some of your annuity if the insurance company that issued it fails. The amount state-run insurance guaranty associations guarantee varies by state, but it is typically $100,000 – $250,000 for annuity contracts.
Annuities are popular investment options for retirees because they offer a relatively low level of risk. Still, is there some risk involved in purchasing an SPIA. To minimize this risk, you should consider:
- Diversifying Investments — Even if you decide 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.
- Research the Insurance Company – 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 your annuity. Make sure you know the coverage limit, and also how this limit may change if you move out of state.