Single Premium Immediate Annuity: LIFETIME INCOME, STARTING NOW
Although most people are familiar with saving and investing for the future, many are not aware of the options that are available for receiving lifetime income in retirement. In the past, employers oftentimes offered defined benefit pension plans (i.e., “pensions”) that provided a regular and predictable income stream to retired employees – and in some cases, income was also paid to the employee’s surviving spouse.
But today things have changed. Due in large part to the vast expense of keeping pensions in place, most companies have now moved from offering defined benefit pensions to defined contribution plans. The most common of these is the 401(k).
While there are some nice tax-related benefits that come with being a 401(k) plan participant – such as pre-tax contributions and tax-deferred growth – the downside is that the responsibility for the income that is generated from these savings has fallen to the individual employee/retiree.
So, how can you secure lifetime income, starting now?
One option is the single premium immediate annuity.
Single Premium Immediate Annuities (SPIAs)
With a single premium immediate annuity, or SPIA, a lump sum of money is deposited, and an income stream is paid out, typically for the remainder of the annuitant’s lifetime. The income usually begins after the contribution has been made into the annuity – or at least within one year. This is in contrast to a longevity, or deferred income annuity (DIA), which doesn’t typically begin making income payments until a time in the future (in some cases, up to 30 or 40 years).
In return for the contribution into a SPIA – which is also referred to as a premium – the insurance company will guarantee a fixed payout of income going forward. Income is usually paid out on a monthly basis.
Why Consider a Single Premium Immediate Annuity?
Because many employers have done away with the traditional defined benefit pension plan, a single premium immediate annuity, or SPIA, allows individuals to move money from an IRA, 401(k) and/or other types of retirement savings to a vehicle that will produce ongoing income. This guaranteed income can help to alleviate the worry about running out of money in retirement.
There are several benefits to owning a SPIA as versus more “traditional” income vehicles such as CDs or bonds. These can include:
- Higher Return Potential – One benefit of SPIAs over “safe” vehicles like bonds and CDs is their potential for higher returns. It is important to note, however, that while bonds and CDs are FDIC insured, SPIAs are backed by the claims paying abilities of their issuing insurance company.
- Protection from Creditors – In many states, immediate annuities may be protected from the claims of creditors, meaning that individuals can still continue receiving an income from the annuity – even during times of financial hardship.
- Benefit of the Exclusion Ratio – The exclusion ratio is the amount of an annuity’s income that is considered to be return of principal. Because this portion of an annuity’s income has typically already been taxed, it will not be taxed again. Therefore, an immediate annuity will oftentimes attract a lower amount of current tax when compared with other types of retirement vehicles such as the traditional IRA or the 401(k).
- Guaranteed Lifetime Income – Certainly, one of the biggest benefits of the SPIA over more traditional income-producing investments like bonds is the guaranteed lifetime income that they can provide. Not only can this income be offered to the annuitant, but also to a joint annuitant (such as a spouse), if the joint lifetime income option is chosen.
How Do SPIAs Pay Income?
Single premium immediate annuities can provide you with a predictable stream of income in a similar manner to a defined benefit pension plan. Because of this, you’ll know exactly how much income to count on every month. While most SPIAs will pay out income on a monthly basis, there are usually other options available, such as annual and quarterly payments.
In addition to the payment frequency, there are options within most SPIA contracts for additional guarantees. Beware that each of these options will change the payout rate somewhat, so be sure you are comparing apples to apples when shopping for a quite. Read on for details.
Pros and Cons of Single Premium Immediate Annuities
There are both advantages and drawbacks to owning a single premium immediate annuity. For example, some of the key benefits include the ease with which they generate an income stream – which can essentially make retirement income planning much easier.
Also, a SPIA could allow for a higher withdrawal rate than can safely be taken from a portfolio that contains stocks, mutual funds, and even bonds, over the course of a long retirement. Because of this, a single premium immediate annuity may allow you to retire on less money than you would otherwise need with a “traditional” portfolio containing a mix of stocks and bonds.
In addition, in order to help keep pace with the rising cost of goods and services over time, a SPIA may allow you to adjust the income payout upwards each year. (Doing so, however, will usually require an additional amount of paid-in premium).
In return for the immediate guaranteed income that you receive from a SPIA, there are some tradeoffs to consider. One of the first to consider are some protections for your principal. These riders are worth your consideration because if they are not selected, in some cases when the annuitant (the individual who is receiving the income) dies, the insurance company may retain the unreturned premium with no money paid out to your heirs.
When choosing a life only income annuity, the big gamble is your own life expectancy. It’s like the opposite of term life insurance- if you only receive a few payments prior to passing away, the premium invested in a SPIA may be lost. That said, if you live a long life – and in turn, receive many years of income payments – you could end up getting much more than you contributed.
With that in mind, it oftentimes makes sense to commit a portion of your overall portfolio to a SPIA – for long-term guaranteed income – while committing another portion to other viable alternatives that fit with your long- and short-term objectives.
Customizing Your Single Premium Immediate Annuity
In order to further “customize” a single premium immediate annuity to meet your particular goals, you may be able to choose some income alternatives that still allow you to receive a set amount of incoming cash flow, while also ensuring that your money doesn’t disappear if you die early.
SPIA Life with Period Certain
For instance, you could choose a life with period certain income option. Here, the SPIA will still guarantee you a lifetime payment, regardless of how long you need it. But, in the case of the unexpected, the income would still continue for your beneficiary(ies) for a set period of time.
As an example, if you chose the option of “life with 10 year certain,” you would continue receiving income – even if you live for many years after the payment starts. But, if you passed away in year 3, your heirs would still receive income from the annuity for another 7 years. (Alternatively, if you pass away in year 12, the income stream stops).
It is important to note that the longer the guaranteed period of income is, the smaller the dollar amount of each payment will be.
SPIA Joint Life Income
If you want to ensure that your spouse will continue to receive lifetime income, even after you’re gone, you could opt for the joint life income option. Here, the income stream from the SIPA will continue for the remainder of both individuals’ lives.
SPIA Return of Premium
Unlike in the past, there are several different SPIA variations in the market today – including an alternative that allows survivors/beneficiaries to receive back the initial premium that was paid in.
For example, choosing the life with installment refund option can provide a guaranteed stream of lifetime income to the annuitant, while also ensuring that 100% of the initial remaining premium goes to a named beneficiary if the annuitant passes away before receiving it.
How is Income from a SPIA Taxed?
The taxation of income from a single premium immediate annuity will depend on whether the annuity is qualified or non-qualified. For instance, with a non-qualified annuity, the money that goes into the annuity contract has already been taxed. Therefore, only a portion of the income received will be taxable.
In contrast, a qualified immediate annuity is purchased with pre-tax money. These funds are oftentimes moved over from a traditional IRA and/or 401(k) plan, where the deposits were made before income tax was deducted. While the funds are allowed to transfer tax-free from the IRA or 401(k) to the SPIA, the income that is paid out from the SIPA to the annuitant will be fully taxable as ordinary income.
Read more: Understanding Taxation of Annuities
QLACs- Qualified Longevity Annuity Contracts
A variety of a single premium annuity using qualified funds is known as a QLAC. IRS legislation allows for qualified accounts such as an IRA or 401K to acquire deferred lifetime income annuity income streams that comply with required minimum distribution requirements. While more of an ‘Income Later’ type of annuity contract, there are many aspects of QLACS that are similar to SPIAS, and investors looking for lifetime income but who are not sure if they need the income to start right away may be wise to consider QLACS or other deferred start income annuity products that may better suit their needs.
Read more: Deferred Income Annuities
Who Should Consider a SPIA?
While single premium immediate annuities can offer some great benefits, these financial vehicles are not right for everyone. But you may want to consider a SPIA if are already – or you soon will be – retired and in need of an income stream to help supplement Social Security and/or other income sources.
Those who are in good health, and who anticipate living a long life in retirement, may also want to consider the purchase of a single premium immediate annuity. That is because a SPIA can guarantee an income stream that cannot be outlived – regardless of how long it is needed.
How to Secure Lifetime Income Now
There are many different types of annuities available today. But these products are not all created equal. Because the purchase of a single premium immediate annuity is a long-term (and irreversible) commitment, it is recommended that you first consult with an annuity specialist to narrow down the best alternative for you.
At DCF Annuities, our focus is on educating consumers about how annuities work, and how they may – or may not – work in particular scenarios. If you’d like to learn more about whether or not an annuity is right for you, contact DCF Annuities for more information.
When creating a safe- growth strategy within their retirement plan, many investors will turn to fixed annuities. That’s because these financial vehicles offer guaranteed growth rates, principal protection and tax-deferred growth. And while it’s rarely used, fixed annuities also offer the option to annuitize, or create a systematic and regular income that you can count on.
Even within the realm of fixed annuities, though, there can be many different options to choose from. Because of that, it is recommended that you first have a good understanding of how fixed annuities work, and how they may – or may not – be a good fit for you.
What are Fixed Annuities and How Do They Work?
In their most basic sense, fixed annuities represent a contract between an individual and an insurance company that guarantees a safe rate of growth. They are most commonly used as a multi- year, guaranteed, safe money alternative to CD’s and bonds, and they carry also the option to turn into an income stream in the future.
With a fixed annuity, premiums are typically paid as a lump sum and are intended to last many years. Contract lengths vary, and the initial premium may be made with cash / non qualified funds, or with qualified funds, such as an IRA, 401K or an employer-sponsored retirement plan.
Additionally, there are types of fixed annuities that permit contributions over a period of time. These are a great safe growth saving vehicle.
The money inside a fixed annuity offers a fixed rate of return that is set by the offering insurance company, and the funds grow on a tax-deferred basis.
This means that there is no tax due on the gain that takes place inside of the annuity until the time of withdrawal, which allows the money to grow and compound more – sometimes much more – than a comparable taxable investment. Because of this, fixed annuities are often used as a good, safe CD alternative.
Most fixed annuities will allow you to “lock in” an interest rate for a fixed period of time, such as three, five, or seven years – regardless of what happens in the market. These are known as MYGAs, or multi-year guaranteed annuities. With an MYGA annuity, you can count on this pre-determined rate – and, once that time period has elapsed, you can usually renew the contract for another set period of time.
Depending on the annuity, you may obtain additional benefits. Almost all annuities allow for withdrawals of 10% of the contract value per year without penalty. Additionally most have penalty-free withdrawals for a terminal illness and/or the need to reside in a nursing home. There may also be a death benefit paid out to a named beneficiary in certain situations. Some annuities include these benefits at no added charge, while others may have small rider fees. Be sure to read the fine print.
Most people who are retired or approaching retirement will purchase fixed annuities for the safety and protection of principal they offer.
What Is The Yield On a Fixed Annuity?
Fixed annuity rates vary with the market. Fixed annuity premiums are typically invested in an insurance company’s general account, which is comprised of vast holdings of safe assets like bonds, commercial mortgages, and other safe instruments. The insurance company’s asset managers know with relative certainty from year to year what their yield on this general account will be, and therefore, the carriers can make multi-year rate commitments to annuity buyers and ensure profitability.
For example, let’s say that the insurance carrier offers a certain minimum rate of return on a fixed annuity. In this case, the insurance company is then able to project what the accumulated contract value will be over a period of time.
Because fixed annuities are a type of insurance contract, they provide some of the same tax benefits, such as safety of principal and tax-deferred growth of earnings. In fact, tax will only be paid either when the annuity’s earnings are withdrawn, or if the contract is annuitized (i.e., converted to an income stream). The insurance company also guarantees that the principal will be safe, no matter what occurs in the market.
Once the annuity’s initial guarantee period has expired, the rate may be renewed for another set period of time, or alternatively, it may be adjusted based on the prevailing yield that has been earned in the insurance company’s account.
This account is the same “pool of money” that backs up the return on fixed indexed annuities – hence the FIA name. Yields in this market generally range from 3% to 3.75% – however, they are always changing. In some instances, insurance carriers that have a lower credit rating may offer higher “teaser” rates of 4% or more. But be careful before you commit to a higher yield before you read all of the annuity’s fine print.
One reason for this is because the higher rate may only last for a short period of time, and when it comes time to renew, you could be stuck for the long term with a much lower rate than you anticipated. On top of that, most annuities impose surrender charges if you withdraw more than 10% of the contract’s value within a certain period of time. (This is known as the annuity’s surrender period). In this case, it could be quite costly for you to get out of the annuity if it doesn’t perform the way you had anticipated it to.
In any case, it is highly recommended that you work with an annuity specialist who has a good relationship with a number of insurance carriers in the market. That way, once your objectives are determined, the agent can go out into the market place and find an annuity that works well for you.
How to Chose and Use Fixed Annuities
Although annuities may seem to offer similar benefits from one to another, the truth is that the benefits you get from an annuity can vary a great deal. That’s why it is important to first determine your specific needs, and then fit an annuity that can best match.
Some of the key factors in choosing the right fixed / multi-year guaranteed annuity include the:
- Interest rate (both initial and renewal options)
- Desired term (i.e., how long you want to lock in the initial rate)
- Purpose of the money (whether you prefer to let the money accumulate within a safe financial vehicle, or you plan to take an income stream – although the former is rarely used)
If you already own an annuity, and it isn’t meeting your objectives, you could consider exchanging it for another annuity. In this type of transaction – which is referred to as a 1035 exchange – you can exchange one annuity for another income tax-free.
According to the IRS, a 1035 exchange is a type of replacement transaction – and as such, it must follow certain guidelines. In this case, for instance, you may not directly take receipt of the money from your current annuity and then place it into the new product. Rather, the funds must pass directly from one annuity to another. That is how the transaction attains its tax-free status.
Based on IRS regulations, you can directly transfer, tax-free, a life insurance policy for another life insurance policy, an annuity for another annuity, or a life insurance policy to an annuity. However, you may not exchange an annuity for a life insurance policy.
There are a number of factors that should be considered before you move forward with a 1035 annuity exchange. For instance, be sure to fully evaluate the new benefits that you may receive as versus what you are currently getting. You also need to be mindful of any surrender charges that you may incur on your current annuity.
How is Income from a Fixed Annuity Taxed?
The taxation of annuity income or withdrawals is dependent upon whether the annuity is qualified or non-qualified. For example, if the funds that you contributed into an annuity have not yet been subject to tax (such as those from a traditional IRA or 401k plan), then 100% of the money that you receive will be taxed.
However, if the money that you contributed to the annuity has already been taxed, then only the portion of your income or withdrawal that represents gain will be subject to taxation. The portion that represents a return of your contribution will be received tax-free.
In addition to taxes, you could be required to pay a penalty to the IRS if you access your funds before you turn age 59 ½. In this case, an additional 10% “early withdrawal” penalty will be incurred on the funds you withdraw.
What Happens If You Take Money Out of a Fixed Annuity
Most deferred fixed annuities will allow you to access up to 10% of the contract’s value penalty-free during the surrender period. A surrender period is a set period of time after you have purchased an annuity where you could incur a penalty for withdrawing funds from the account.
Annuity surrender periods can last for just a few short years, or they can last for 10 or more years, depending on the annuity. Typically, the amount of the surrender penalty will decrease over time until it finally reaches zero.
Pros and Cons of Fixed Annuities
There are both pros and cons to consider before purchasing a fixed annuity. Some of the key benefits to owning a fixed annuity can include:
- Safety of principal
- Guaranteed rate of return
- Predictable stream of income (possibly even for the remainder of your lifetime)
Some of the items to consider before moving forward with the purchase of a fixed annuity, however, are:
- Lower rate of return (as versus that of equity-related investments)
- Liquidity (particularly during the annuity’s surrender charge period)
Is a Fixed Annuity Right for You?
Fixed annuities can provide you with both protection of principal, as well as a steady return over time. And, depending on your specific goals, fixed annuities can also provide a fixed stream of income, possibly even for the rest of your life.
It is important to keep in mind, though, that any annuity represents a longer-term financial endeavor. With that in mind, be sure that the funds you contribute to an annuity will not be needed in the future for emergencies.
How to Choose the Best Fixed Annuity
Knowing what your short- and long-term financial objectives are before you purchase an annuity can help you to narrow down the options that are best for you. In addition to the annuity itself, it is also important to check the credit rating of the offering insurance company.
This can help you in determining the financial strength and stability of the insurer, which in turn, can have an impact on its income guarantee. Most insurance carriers are rated by A.M. Best, Standard & Poor’s, Fitch, and/or Moody’s. These ratings can typically be found on the insurance company’s website, or by checking with an annuity specialist.
Other items to consider when purchasing a fixed annuity include the interest rate provided by the carrier (both the initial rate, and the renewal rate), as well as the annuity’s surrender charge period.
Taking the Next Step to Securing a Fixed Annuity
Although fixed annuities can provide a number of tax and income-related benefits, they can also be somewhat confusing products. Because of that, it is always best to first consult with an annuity specialist before you make a long-term commitment.
At DCF Annuities, we scour the market place to find the right annuities for our clients. We aren’t stuck offering products from just one insurance company – and because of that, we can match you with the very best option for your specific needs and objectives.
Want to learn more about how you can obtain tax-advantaged growth in a safe money environment? If so, just contact DCF for more details.
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