What Is a Single Premium Immediate Annuity (SPIA)?
A SPIA is a contract between a client and and an insurance company designed for income purposes only. Unlike a deferred annuity, an immediate annuity skips the accumulation phase and begins paying out income either immediately or within a year after the client has purchased it with a single, lump-sum payment. SPIAs are also called immediate payment annuities, income annuities and immediate annuities.
This annuity is the oldest type, dating back to the ancient Roman Empire. The word annuity actually comes from the Latin, annua, which means annual payments. Roman soldiers received lifetime annuity payments to compensate for their service in the military.
Some consider it to be the simplest and most consumer friendly annuity, although it represents only a small portion — about 10 percent — of annuities sold each year. Individuals approaching retirement age may choose this type of annuity because they will be able to make large contributions without the limitations of 401(k) plans, IRAs and other popular retirement plans. SPIAs allow seniors to supplement Social Security income and pension plans, which might not provide enough income to cover retirement living expenses. In fact, employees retiring can roll their 401(k) plans into a SPIA to create meaningful income.
How Immediate Annuities Work
Immediate annuities can be customized. Owners can receive payments monthly, quarterly, semi-annually or annually. At the time of purchase, the advisor will customize the needed income stream. Payments can be made over one life or two lives, as guaranteed lifetime payments, and can include beneficiary protection for the client’s heirs. Payments can also be structured over a specific period of time, such as 10 years, which is referred to as “period certain.” Each payment received consists of the premium plus a portion of interest earnings. The interest rate on an immediate annuity can be:
- Fixed
- Adjusted annually for inflation
- Varied with earnings, based on the performance of its subaccounts
In the case of a fixed rate, each payment to the annuity owner will be the same. If the annuity is variable, the amount of each check will be different because the subaccounts will fluctuate. Both of these options help protect payments from inflation, but fixed annuities offer more reliability than variable annuities.
SPIA interest rates are often more favorable than certificate of deposit (CD) and U.S. Department of the Treasury rates.
Purchasing a SPIA
A person or company can purchase a SPIA from an insurance company using a lump sum. This lump sum, or premium, must be paid up front.
The payment amount will be calculated based on the type of annuity purchased, the term of the contract, the age and gender and a number of other factors.
The type of premium used to fund the annuity will impact how payments are taxed. Annuities are insurance products, not investments, and the payment streams they generate are considered a form of income, so they are subject to income taxes.
If the annuity is funded with after-tax dollars, this becomes a non-qualified annuity. This means when disbursements are received a portion of every payment is considered a return of principal, which is not taxed.
The remaining portion of the payment consists of interest earnings and is taxable.
Examples of non-qualified immediate annuity funding sources include:
- Deferred compensation
- After-tax savings
- Money market accounts
- Mutual fund proceeds
- Inheritance
- Life insurance settlements
- Certificates of deposit (CD)
- Deferred annuity that was previously funded with the sources above
Conversely, if an annuity is purchased with pre-tax money, the annuity is qualified, and the entire amount of each payment will be subject to ordinary income tax rates.
Examples of qualified immediate annuity funding sources include:
- Corporate-sponsored defined contribution plans
- IRAs
- 401(k) plans
- Simplified Employee Pension (SEP) plans
- Section 403(b) tax-sheltered annuities
- Section 1035 annuity exchanges
- Annuities previously funded with the sources above
Keep in mind that SPIAs are annuitized immediately, which means their premium is instantly converted to a stream of regular payments. If that is not the client’s goal — for instance, if they have another form of retirement income or would prefer to have a lump of cash accessible for specific reasons — a SPIA is not the right product for them in general.