Are Single-Premium Immediate Annuities (SPIAs) Good Investments?
Single-Premium Immediate Annuities (SPIAs) are fixed annuities that provide annuitants with monthly payments, either for the annuitant’s lifetime or for a fixed period. SPIAs are one of the many products that investors may turn to when they want a financial product that ensures their finances will last their entire lifetime.
Brokers might present a SPIA as a good source of regular income in retirement. SPIAs have grown in popularity as many companies have stopped offering traditional pension plans. They are extremely low-risk investments, with approximately the same amount of risk as a bond and the chance of earning slightly more interest. There are, however, risks associated with certain SPIAs that investors should consider carefully.
How Do Single Premium Immediate Annuities Work?
“Single premium” refers to the lump sum payment that serves as the investment principal. Single Premium Immediate Annuities are “immediate annuities” that start making payments right away, as opposed to deferred annuities. The insurance company uses the annuitant’s money to make investments and pay some interest back to the customer.
One annuity calculator estimates that a 65-year-old man could pay $100,000 for a Single Premium Immediate Annuity and receive a monthly payment of $465.39, or $5,584.68 per year. If he gets a lifetime SPIA and lives at least 18 more years, he will have received his $100,000 payment back and still have guaranteed monthly payments for the rest of his life.
What Happens to SPIAs When the Annuitant Dies?
With a lifetime SPIA, the payments stop when the annuitant dies. The annuitant may die before receiving the full amount of their initial principal payment. In that case, the insurance company keeps the balance and distributes it to their other annuitants as a “mortality credit.”
If an annuitant wants their money to go to their relatives, they should instead purchase a “guaranteed period” SPIA. These SPIAs offer payments for a set number of years. If the annuitant dies before the guaranteed period ends, the money will pass to their beneficiaries. Some insurance companies may also offer a lifetime SPIA with a cash refund that will pay a beneficiary the remainder of the premium not yet paid in monthly installments. Couples can also get joint SPIAs that will continue to make monthly payments after one of them dies.
Investors, bear in mind: Adding beneficiaries to a guaranteed period SPIA usually adds additional costs, which will cut into the already thin amount of interest.
Risks Investors Should Consider
Single-Premium Immediate Annuities can be complex contracts with unforeseen risks. Investors should always shop around to see if there are simpler investment products that will offer them the same financial protection.
SPIAs and Taxes
Brokers may tout the attractive tax features of a SPIA. The IRS will classify most of the monthly payments as a return of principal which are therefore not subject to income tax. Once the premium has finished paying out, however, the payments will be taxable, assuming the annuitant purchased their policy with pre-tax money. (It may be possible to avoid this by buying a SPIA with money that has already been subject to taxes, like an inheritance.)
Besides taxes, a SPIA’s monthly payout may also suffer from the effects of inflation. The point of a SPIA is to provide income that will outlive the annuitant’s savings, but the monthly payout of $465, for example, will probably not have the same buying power 20 years from now. Investors interested in SPIAs should find out what type of inflation protection their insurance company may offer.
Risks to the Insurance Company
There is also a chance, however remote, that the SPIA’s insurance company could go out of business, in which case payments would stop. A major financial crisis could slow down getting a payment out of a SPIA, even if your state backs your insurance company.
Remember, the insurance company is investing the Single Premium Immediate Annuity’s premium. They get the advantage of the full return and not the annuitant. Investors should consider if they can find an investment that will offer them regular payouts as well as healthy returns on their investment.
Investors will have to pay fees to withdraw money from their SPIA. Insurance companies may also not be able to pay the annuitant immediately — their money will probably be tied up in investments. Certain investors will want financial products that offer more liquidity, in which case a financial product that works more like a stock would be better suited for their needs.
SPIAs are meant to insure against the possibility that the investor will outlive their income. Brokers should not recommend SPIAs to clients with serious health concerns.
What Your Broker Should Tell You About Single Premium Immediate Annuities
More complex annuities often mean more of a commission for the broker. Brokers who recommend an investment solely for the sake of their commission could be liable for their investor’s losses.
Brokers should also understand their investor’s financial situation and liquidity needs before recommending a SPIA. They should also factor in any known health risks for their investor. This is part of a broker’s duty to know their customer and abide by the suitability rules set forth in FINRA Rule 2111. FINRA Rule 2111 states that brokers should only recommend financial products that suit their investor’s age, liquidity needs, and financial goals. If you believe your broker did not take these factors into account when they recommended a SPIA, contact a securities attorney to recover your losses.