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.
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.