Key Takeaways
- A SPIA is an insurance product designed to provide a guaranteed income stream, usually for retirees.
- They work by converting a lump-sum investment into regular income payments that begin within a year of purchase.
- When you purchase a SPIA from an insurance company, you can customize the contract to decide how long payments should last.
- The benefits of SPIAs include guaranteed income and a simplified way to plan for retirement, but some drawbacks are the lack of liquidity and the risk of losing purchasing power due to inflation.
What Is a Single Premium Immediate Annuity?
A single premium immediate annuity (SPIA) is a contract between you and an insurance company designed for predictable income. SPIAs are also called immediate payment annuities, income annuities and immediate annuities.
Unlike a deferred annuity, an immediate annuity does not have an accumulation phase. Instead, the contract converts the lump-sum premium into a stream of income that begins paying out either immediately or within a year after you purchase it.
Many consider immediate annuities the simplest and most consumer-friendly category of annuity. According to the Insurance Information Institute, 2022 saw approximately $9.2 billion in sales of fixed immediate annuities. And this figure accounts for only a small portion of overall fixed annuity sales, which reached nearly $210 billion in total sales for the same year.
In 2023, total annuity sales are projected to surpass $300 billion for the second consecutive year.
How Immediate Annuities Pay Out
Immediate annuities work by converting a lump sum into a stream of payments the owner receives each month, quarter or year. When you purchase an immediate annuity, you can customize your income stream with different payout options.
For example, you might choose a single-life annuity that pays out for as long as the annuitant lives. Alternatively, married couples sometimes opt for a joint and survivor annuity, which continues paying out until both annuitants (usually spouses) pass away.
You can also structure payments over a specific period, such as 10 years, which is referred to as a period certain annuity. Period certain SPIAs are less popular than other alternatives but can be beneficial in certain situations. For example, someone who wants to retire early might invest in a period certain SPIA to provide a source of income for a few years until they can begin collecting Social Security benefits.
Each payment you receive from a SPIA consists of your premium plus a portion of interest earnings.
With a fixed immediate annuity, each payment to the annuity owner will be the same. On the other hand, if the annuity is variable, the amount of each check will be different because the subaccounts will fluctuate.
How do immediate annuities pay out?
Learn how an investment today can provide guaranteed income for life.
How Are SPIA Rates Determined?
The interest rate on an immediate annuity can be:
- Fixed
- Annually adjusted for inflation
- Variable, with earnings based on the performance of its subaccounts
Each interest rate option has its benefits and drawbacks. Fixed-rate SPIAs are more reliable and their rates are often more favorable than certificates of deposit (CDs) and U.S. Department of the Treasury rates. However, receiving the same amount of money each year means your payments likely won’t keep up with inflation — a significant risk for retirees.
Immediate annuities with variable rates are more likely to hedge against inflation, as their payments can change based on market performance. But the changing payment amounts make the income from these annuities less predictable.
Purchasing a SPIA
A person or company can purchase a SPIA from an insurance company using a lump sum. They must pay the lump sum, or premium, upfront.
The issuing company calculates your payment amount based on the type of annuity you buy, the term of the contract, your age, sex and several other factors.
Annuities are insurance products, not investments. The IRS considers the payment streams they generate to be income, so the payments are subject to income taxes. But the tax treatment of those income payments is determined by the type of premium used to fund the annuity.
Taxation of your immediate annuity payments depends on where the funds you purchased the annuity with came from. If you buy an immediate annuity in a state that levies a state premium tax on annuities, you’ll pay the premium tax at the time of purchase.
If you fund your annuity with after-tax dollars, you own a nonqualified annuity. This means that when you receive disbursements, the IRS considers a portion of every payment to be a return of principal and that portion is not taxed.
The remaining portion of the payment is interest earnings and is taxable.
If you purchase your annuity with pre-tax money, your annuity is qualified and the entire amount of each payment is subject to ordinary income tax rates. Funds for qualified immediate annuities come from retirement plans like IRAs, 401(k)s, SEP plans and corporate-sponsored defined contribution plans.
Since SPIAs annuitize immediately, your premium is instantly converted to a stream of regular payments. If that is not your goal — for example, you already have another form of reliable retirement income or you would prefer having a lump sum of cash accessible — a SPIA is not the right product for you.
Who Should Buy a SPIA?
This type of annuity is popular with those approaching retirement age because SPIAs offer the option to make large contributions without the limitations of 401(k) plans, IRAs and other popular retirement plans.
SPIAs also enable retirees to supplement Social Security income and pension plans, which might not provide enough to cover their retirement living expenses. In fact, retiring employees can roll their 401(k) plans into a SPIA to create meaningful income for retirement.
Case Study Example
Let’s look at an example of a typical SPIA customer to understand the type of person best suited to the product.
“Typically, the average person that’s buying an immediate income annuity is in retirement or about to retire,” Annuity.org expert contributor Stephen Kates, CFP®, explained.
Like Charlotte in the example above, many retirees face the risk of running out of money once they stop working. By purchasing a SPIA, Charlotte can guarantee that she’ll receive regular income payments for as long as she lives.
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Pros and Cons of Single Premium Immediate Annuities
Understand that purchasing a SPIA involves a trade-off: you’re giving up the liquidity of your savings for a guaranteed income stream you won’t outlive. If securing lifetime income is a priority, then an immediate annuity could be worth losing immediate access to those savings.
SPIAs benefit retirees by providing a reliable income stream without many of the complicated features of other annuities. However, this product may not be ideal for you. Before purchasing an immediate annuity, it’s important to weigh the pros and cons.
- Guaranteed and Immediate Income
- When you purchase an immediate annuity, you transfer risk to an insurance company that, in turn, begins paying you within the first year of your contract.
- Mortality Credits
- Risk pooling, or the spreading of risk across many accounts, allows premiums from annuity owners who die prematurely to be used to pay benefits for those who live beyond their life expectancy. These so-called “mortality credits” can increase your returns above those of other options and, by choosing a lifetime benefit option, you can hedge against ever outliving your available assets.
- No Maintenance Fees
- Immediate annuities rarely have any account management or account maintenance charges.
- Ease of Use
- Purchasers appreciate the easy and reliable payment stream afforded by SPIAs. Once established, an immediate annuity requires no maintenance or work.
- Plan for Retirement
- Many people use SPIAs to fund their retirement. Often, retirees prefer the product’s reliability to the volatility of the stock market.
- COLA
- For an added cost, you can purchase a cost-of-living adjustment (COLA) rider for your SPIA, which will increase your annuity payments over time depending on how the rate of inflation has increased. However, it’s important to evaluate this option carefully with a financial advisor because this feature typically produces substantially lower beginning payments.
- One-Time Withdrawal
- Some insurance companies offer one-time cash advance options for annuitants who have an immediate need for cash. Otherwise, you cannot change your annuity and it will only pay the set amount on the disbursement schedule.
- Legacy Options
- There is some misconception that SPIAs will not pay benefits to your heirs when you pass. While it is possible to elect a payment optimized for the highest income that contains no death benefits (sometimes referred to as a straight life annuity), most SPIAs sold contain death benefits.
Pros of SPIAs
- Loss of Control
- The most significant drawback is that immediate annuities are irrevocable. Once you exchange your lump-sum payment for periodic distributions, you no longer have control or access to your money.
- Loss of Purchasing Power
- If your SPIA does not contain an inflation adjustment feature, your payment may not be keeping pace with inflationary trends.
- Variable Annuity Risk
- Most SPIAs purchased today are fixed SPIAs. If your SPIA is variable, which means it contains market risk, then your payment stream could decline based on changes to subaccounts invested in risk-based assets.
Cons of SPIAs
Frequently Asked Questions About Immediate Annuities
Immediate annuities are generally good investments for people close to retirement who want guaranteed income. These types of annuities are not suitable investments for people who seek wealth accumulation or capital appreciation, as they do not offer these benefits.
Unless you have purchased a rider that allows for a beneficiary, the account balance of your immediate annuity will be distributed to other annuity holders within the pool of annuitants that have contributed premiums to the insurance company’s general account.
Consider purchasing a SPIA if you want the benefit of tax deferral and the security of a pension-like income stream in retirement that begins within a year of your purchase.
An immediate annuity pays a fixed amount set by the insurance carrier. The insurer calculates the payment amount based on multiple factors, including the annuitant’s age, sex and health; the amount invested; and current interest rate environments.
Editor Malori Malone contributed to this article.
