All about Single Premium Immediate Annuities (SPIAs)
Single Premium Immediate Annuities (SPIAs) are the oldest type of annuity, dating to Roman times. They have been sold in the U.S. more than 200 years.
A single premium immediate fixed annuity is the simplest annuity you can buy. You make a single premium payment in exchange for an immediate stream of income that is fixed for the duration of the contract.
You can also buy a SPIA that makes variable payments. A variable immediate annuity allows you to invest your premium in mutual funds or other vehicles that can increase in value. If those investments grow, the amount of your income payments will grow as well. However, the opposite holds true if those investments decrease in value.
Most SPIAs pay lifetime income, but you can also purchase them to provide income for a set period of time.
If you select lifetime income only for one life, the payments will end when you pass away, even if that occurs shortly after you purchase the annuity. You can also include another person, such as a spouse, and the payments will be made as long as either of you is alive.
You can also select lifetime income that will guarantee that the annuity makes payments for a minimum period of time so that you get at least the amount of money you put in. If you die before the end of this minimum period, the payments will continue to a designated beneficiary.
If you select annuity payments for only fixed period, the payments stop at the end of the period. If you die before the end of the period, payments will continue to a designated beneficiary for the rest of the period.
How much you receive from a SPIA
The annual income you receive from the annuity is called the payout rate, which is a percentage of the total amount of premium you paid upfront. For example, if you invested $100,000 in an immediate annuity with a 6 percent payout rate, you would receive $6,000 annually until you pass away. Comparing payout rates based on your current age is one way to decide which immediate annuity to buy.
If you choose lifetime income from a SPIA, the payout rate will be based on your age and gender. The older you are at the time of purchase, the larger the amount of income the annuity will pay. Women will also receive higher payouts because they have greater life expectancies. If you choose joint annuitants, the payout will be lower than if you choose a single life annuity.
With an immediate annuity, you know the exact amount of retirement income provided by the annuity. And you know that income will last until your death if you choose lifetime income.
SPIAs typically generate more guaranteed income than any other type of investment. Fixed income investments like bonds and CDs are tied to market interest rates, which have been low for several years and therefore offer little return. SPIAs on the other hand pay a guaranteed monthly cash flow due to return of principal — the amount you put in — not on investment earnings.
Immediate annuity disadvantages
One of the potential downsides of buying an immediate annuity is that the money is no longer accessible for, say, a medical emergency or other expense. Therefore, retirees should have other retirement assets, in addition to an immediate annuity, just in case.
And there exists the possibility you will pass away a few months or few years after purchasing the annuity. If so, you would not have received near the amount of income you put into the annuity. For some, this is a risk worth taking in exchange for the peace of mind of knowing they will have some form of income for the duration of their retirement. However, if you don’t have a long life expectancy, you probably do want to tie up your money in an annuity.
How annuity income is taxed
The tax treatment on your immediate annuity will depend on how you funded the contract. If you transferred money from a 401(k) or IRA, your annuity payments will be taxed as regular income. That’s because those instruments contain money you have not paid tax on.
If you use cash or other funds that have been taxed, than only a portion of your annuity income will be taxed. You would not pay tax on the portion of your payments that are considered a return of your original premium. The taxable portion is what your annuity pays above and beyond what you put into it.