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 be highly tailored — owners can receive payments monthly, quarterly or yearly, and the payments can come 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 — as well as 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. If the annuity was purchased with after-tax dollars it is non-qualified, meaning the owner will only have to pay income tax each year on any interest earnings.

The interest rate on an immediate annuity can be:

  • Fixed, or permanent
  • 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. These options help protect payments from inflation rates.

Purchasing an Immediate Annuity

A person or company can purchase an immediate annuity 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 find 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 fund the annuity with a premium that has not been taxed already or was previously exempt from income taxes, it is considered a qualified immediate annuity and will be taxed when payments are made. If you fund the annuity with a premium that has been taxed already, it is considered a non-qualified immediate annuity and will not be subject to income tax again.

Examples of qualified immediate annuity premiums include:

  • IRA
  • Simplified Employee Pension Plan
  • Sheltered annuities
  • Section 1035 annuity exchange

Examples of non-qualified immediate annuity premiums include:

  • Deferred compensation
  • After-tax savings
  • Money market accounts
  • Mutual fund proceeds
  • Inheritance
  • Life insurance settlement

Can You Sell A Single Premium Annuity?

Yes, you are able to 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 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.

Pros

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 sub-accounts lose money. This means you have guaranteed income, no matter what happens in the stock market.
  • 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.

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Cons

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. reached nearly $112 billion by the end of Q2 2016, slightly above sales at the same time in 2015. During that quarter, fixed annuity sales reached $29.5 billion and variable annuity sales reached $26.4 billion. 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.

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