It wasn’t too long ago when people would plan their whole lives around a leisurely and secure retirement. Buoyed by huge equity balances in their homes, and their bulging 401(k) plans, most people in the 1990s and early 2000s sailed into retirement without a care in the world. These days, pre-retirees are planning on working longer, living on less, and hoping that they’ll have enough income to last their lifetimes. What a difference a decade makes. It’s no wonder that SPIA annuities are, once again, garnering the attention of the retiring population.
SPIA annuities (Single premium immediate annuities) may not be the cure-all for people whose retirement plan accounts come up short, but for retirees who find themselves losing sleep over the possibility that they may outlive their income, they provide the ultimate cure. With over 70% of Baby Boomers laying awake at night worried over their retirement income, understanding SPIA annuities may be their first step towards getting the sleep insurance they need.
SPIA Annuity Basics
The concept of a SPIA is actually fairly simple: An individual deposits a lump sum of money (single premium) with a life insurance company in exchange for a promise to provide a continuous stream of income for a specific period of time or the lifetime of the individual. They enter into a contract, and the future payments become an obligation of the life insurance company. The depositors give up access to their deposit except through the period payments, and the insurer guarantees that they won’t outlive their income.
Drilling Down on SPIAs
When investors make the decision to invest in an SPIA, they approach the life insurer with one of two known variables: The amount of income they want to receive, or the amount of money they have to deposit. For the first variable, the life insurer will calculate how much capital needs to be invested in order to generate the amount of income needed. For the second variable, the insurer will calculate how much income can be generated from the invested capital. In both cases, the insurer applies the same factors: the investor’s age, the number of payment periods involved, and an assumed rate of interest that will be paid on the annuity balance. For lifetime SPIAs, the insurer determines the number of payment periods based on the investor’s life expectancy.
The payout amount is determined by dividing the total number of payments into the amount capital available which includes the original deposit plus the project interest accumulation over the entire payment period. An exclusion ratio is calculated to determine the amount of the payment that will be excluded from taxes because it is a return of principal.
The Insurance Aspect of SPIA Annuities
SPIAs are, essentially, longevity insurance policies. Whereas life insurance insures the risk of dying to soon, SPIAs insure the risk of living too long. Even though the payout amount is calculated using a person’s life expectancy to determine the number of payment periods, payments are guaranteed to continue even if life expectancy is exceeded.
Leaving SPIAs Behind
SPIAs that are structured as a “single life” annuity, guarantee payments for as long as the annuitant is alive. When the annuitant of a single life annuity dies, the life insurer retains the remaining annuity balance.
In situations where a spouse is involved, a “joint life” annuity would ensure that the surviving spouse would continue to receive annuity payments for the remainder of his or her life. In this case, the life insurer is insuring two lives, so the payout amount is adjusted down to offset the cost of insurance.
If the annuitants want to have their heirs receive the annuity balance after both deaths, a refund option can be added that will pay the balance of the annuity to named beneficiaries in installments.
Planning for Maximum SPIA Income
Because the SPIA payout rate is calculated using the number of payment periods, the fewer payment periods there are, the higher the payout amount will be. With a shorter overall payment period, the exclusion ratio will be higher which means the amount of the payment excluded from taxes will be higher. Ideally, SPIAs should be used as late in retirement as possible, but, of course, this strategy can only work if there are other sources of retirement income that can cover living needs in the early stage of retirement. This strategy would make sense for someone who plans on generating income from a job or a business while in retirement enabling them to delay the income from an SPIA annuity.
Buying the Right SPIA Annuity
SPIAs are available through most major life insurance carriers of which there are hundreds. It can make the task of selecting just the right one very daunting. Online annuity sites make it fairly easy to compare payout rates along with the various payout structures, however, it could still involve looking at dozens of SPIAs. When trying to narrow the field in a competition, it is important to have a set of criteria that will enable you to select out products quickly and easily.
Perhaps the most important criterion for selecting an SPIA is the financial strength of the life insurer that is obligated to make your annuity payments. Your annuity payments are secured by the assets of the issuing life insurer, so it would make sense to choose among those who are deemed to be in the strongest financial condition.
Life insurers that earn the highest ratings from the independent rating firms are considered to be the strongest financially and able to meet their obligations in the toughest of economic environments. If, in your comparisons, you find that the difference in payout between an “A+” rated company and a “B+” rated company is only $35 a month, is that a sufficient amount of money over which to lose sleep? Probably not. The guarantees and security of SPIAs are only as good as the company that backs them.