Single Premium Immediate Annuities (SPIAs)
What is a Single Premium Immediate Annuity?
A Single Premium Immediate Annuity is a contract between you and an insurance company. By paying in a lump sum of money, you are guaranteed to receive a series of payments over a period of time. The amount of the payment is determined by both the current interest rate at the time your contract is issued and by choices you make from a wide variety of payment options. Once your contract is issued, your payments are fully guaranteed for the period of time you have chosen.
Why do Immediate Annuities pay tax-favored income?
If you use after-tax funds to purchase a single premium immediate annuity, the income payments you receive are only partially taxable. The non-taxable portion of each payment is a level percentage that represents the return of principal over the life of the contract. Depending on your age and the payment option you choose, this percentage will vary. If you are using tax-qualified funds (IRA, TSA, 401k money for example) to purchase your Single Premium Immediate Annuity, the payments you receive are generally fully taxable as you receive them because they represent funds that have not been taxed before.
Do Immediate Annuities have investment risk?
Once your contract is issued, you can count on your payments not to change in amount or frequency. You will enjoy the financial security of a guaranteed income with no investment risk, economic conditions or investment returns may change, but your payment is guaranteed to remain the same.
What payment options are available with an Immediate Annuity?
A Single Premium Immediate Annuity offers a variety of options so you may tailor your income schedule to suit your needs. You can choose to receive payments, monthly, quarterly, semiannually or annually. The payment options include:
- 1. Period Certain Only Annuity
- "Period Certain" means a number of years you choose. Payments will continue for the duration of the number of years you choose, and then cease. If you should die before the end of the stated number of years, your beneficiary would continue to receive the payments for the remainder of those years.
- 2. Life Only Annuity
- In this type of immediate annuity, payments will continue for the rest of your life. You cannot outlive your income. Upon your death, payments stop.
- 3. Life and Period Certain Annuity
- Life and period certain annuity means payments will continue for the rest of your life, but for no less than the stated number of years. If you should die before the end of the stated number of years, your beneficiary would continue to receive the payments for the remainder of those years.
- 4. Life Only with Guaranteed Minimum Option
- Payments will continue for the rest of your life. If you should die before you have been repaid your initial investment, the balance of your initial investment will be paid in like installments to your beneficiary.
- 5. Joint and Survivor Annuity
- Payments are guaranteed during your lifetime and the lifetime of someone you choose. After the death of one, payments continue for the lifetime of the surviving person. You can choose to have either full payments, or a percentage you choose, to continue for the lifetime of the survivor. You can also specify a period certain, and if both individuals were to die within the period certain, payments would continue to the named beneficiary for the remainder of the period certain.
Important Points Regarding Life-Only Annuities
Under the life-only option type of annuity, if you purchase an annuity at age 65 and live to age 95, you will receive more than $242,000 over 30 years, the equivalent of a 7.2 percent annual compounded return on the $100,000 premium. If, however, you die after one year, you will get back just a tad over $8,076, and your heirs can kiss the rest of the money goodbye. Your age and gender also determine how big a check you get. The older you are, the bigger each monthly payment because, on average, you will die sooner. Men get higher payouts than women the same age because men, on average, die younger. The concern is obviously if you die earlier than you expect, you will lose your money. On the other hand, these immediate annuities provide more dependable income than any other financial product; in addition, payout rates are higher than those available if you invest in bonds on your own. These higher returns are due to the fact that the payouts, which include both interest and return of principal, are based on the assumption that many annuity holders will die before reaching their life expectancy. In short, insurance companies use funds remaining from those who die sooner to pay those who live longer than expected.
Immediate Annuity Investment and Age
Buying immediate annuities guarantees income-hungry retirees a lifetime stream of income. Many invest approximately a quarter of their funds in an immediate-fixed annuity. One such approach to immediate annuity investing, one which will guarantee a high income level and makes sense if you expect you will live to a ripe old age, is to make that investment, but not until age 75 or so. This approach will get you a generous income stream based on your shorter life expectancy.
How do interest rates impact Immediate Annuities?
The size of those checks depends not only on your age and gender, but also on current interest rates. Suppose you are a 65-year-old man and you buy an immediate-fixed annuity. A $100,000 investment will give you an annual return of approximately $7,740. If you are a 65-year-old woman, you will get somewhat less, approximately $7,296; reflecting your longer life expectancy. More than anything else, with immediate annuities you are gambling on your own longevity. Ultimately, this has much more bearing on the benefits of this type of investment than does interest rates. If you live a long time, you will collect heaps of income and the annuity could turn out to be an astute investment. If you die soon after purchasing the annuity, you will get precious few monthly checks and your heirs will likely get nothing.
A Strategy to Lessen Interest Rate Impacts on Immediate Annuities
One popular strategy is to wait until your 70's to buy an immediate annuity, so that the payout is driven less by interest rates and more by the insurance company's estimate of how long you might live. There are other advantages to postponing your annuity purchase. By waiting, you will get to see how your health holds up during the initial retirement years. If your health deteriorates a lot, you may decide it isn't such a good idea. The delay will also give you a chance to figure out whether you need the extra income. You may find buying annuities isn't necessary, either because you spend less than you imagine or because you earned higher-than-expected returns during your initial retirement years.
Don't Delay Too Long
One risk of delaying buying annuities can be that in the scramble to cover living expenses, you start to exhaust your retirement savings. If your nest egg becomes too depleted, you'll lose the opportunity to buy an annuity that guarantees a reasonable stream of income. When you need the income, that's the time to invest in it.