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Should you use a single premium immediate annuity?

Whether you’re a seasoned investor or just getting your feet wet, there’s a good chance that you’ve heard of an annuity. This financial product doles out regular payments for a set amount of time to purchasers who invest a lump sum upfront. However, there are many different types of annuities. A single premium immediate annuity (SPIA), takes your funds and turns them into guaranteed payments. Usually purchasers of these annuities do so to receive guaranteed payments for life, insuring them against outliving their money. Read on to learn more about SPIAs, including their pros and cons, before deciding if it’s the right one for you and your financial situation.

Single Premium Immediate Annuities: The Basics

Like other types of annuities, a single premium immediate annuity (SPIA) is a contract between an investor and an insurance company. It’s designed to supplement retirement income. However, with a SPIA, the annuity purchaser invests a large lump cash sum upfront and elects to begin receiving payments at some point within a year. This means SPIAs skip the accumulation phase and go directly to the annuitization phase. They’re also known as immediate annuities and income annuities.

You choose the frequency and duration of your annuitization payouts when you buy into it. An immediate annuity most commonly guarantees payments for the rest of your life, but you may also have the option of continuing payouts to your spouse or heirs if you die before a certain period of time has elapsed.

Investing In a Single Premium Immediate Annuity

Should you use a single premium immediate annuity?

To invest in a SPIA, you’ll need a lump sum of cash. This will be used to purchase the annuity from an insurance company. You’ll then select the type of interest rate (fixed or variable), along with the duration and frequency of annuitization payouts. The latter can be monthly, quarterly or annually.

The lump sum can come from pre-tax funds, such as a 401(k), or it can be from money that’s already been taxed. Of course, whether or not that money has already been taxed will determine if your payouts are subject to income tax.

Benefits and Potential Drawbacks

Like many annuities, there are both pros and cons that come with buying into a SPIA. This type of annuity provides a steady, predictable stream of income in retirement, plus tax-deferred growth. SPIAs don’t always have a clearly stated account fee. Instead they’re often worked into the interest rate. This could be seen as a benefit and a drawback depending on the type of investor.

If you’re really worried about your annuity payments throughout the course of your retirement years, consider a cost of living adjustment (COLA) rider to go along with your SPIA. As the name suggests, this rider will increase your annuity payments in tandem with inflation.

One drawback of this type of annuity is the potential loss of control over your funds. If you don’t have a large amount of money saved, it may not be smart to invest in an annuity. You might not be able to access that money should you need it either. Remember, annuities as a whole are relatively illiquid.

If you’re receiving payments for the remainder of your life, the risk is that you could die sooner than expected and wind up receiving less in payments than the initial premium. Of course, the converse may also be true – if you significantly outlive the insurer’s life expectancy, you would receive more in payments than you put in.

Finally, as is the case with all other annuities, the success of your investment can depend wholly on the financial health of the insurance company backing it.

The Bottom Line

Should you use a single premium immediate annuity?

Single premium immediate annuities may be a good choice for those who have a large amount of money saved. They could invest in a SPIA and begin the annuitization process and receive payments immediately. However, a SPIA might not be right for every investor. Consider all of your options first so that you find the right investments for your financial situation.

Tips for Investors

  • Like other annuities, a SPIA is a contract between the annuity holder and an insurance company. This can determine the fate of your investment. Remember, an annuity is only as valuable as the insurance company backing it.
  • Take the time to consider all of your investment options if you have a large lump sum of cash. An annuity might be the right fit, but there are other ways to invest. Start by analyzing your risk tolerance and then figure out the best way to diversify your portfolio.
  • If you’re not sure whether a SPIA is the right investment vehicle for you, consider working with a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/eggeeggjiew, ©iStock.com/D-Keine, ©iStock.com/EricGerrard

Rachel Cautero Rachel Cautero writes on all things personal finance, from retirement savings tips to monetary policy, even how young families can best manage the financial challenges of having children. Her work has appeared in The Atlantic, Forbes, The Balance, LearnVest, SmartAsset, HerMoney, DailyWorth, The New York Observer, MarketWatch, Lifewire, The Local: East Village, a New York Times publication and The New York Daily News. Rachel was an Experian #CreditChat panelist and has appeared on Cheddar Life and NPR’s On Point Radio with Meghna Chakrabarti. She has a bachelor’s degree from Wittenberg University and a master's in journalism from New York University. Her coworkers include her one-year-old son and a very needy French bulldog.
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