Single Premium Immediate Annuity: Is A SPIA Right For Your Retirement?
When you retire, one of the greatest challenges is making sure you don’t outlive your money. With a single premium immediate annuity (SPIA), you can turn some of your savings into a stream of guaranteed payments that can last for your entire life. This can make SPIAs valuable retirement tools, but they’re not perfect for everyone. Here’s how to decide if a SPIA is right for you and your retirement plan.
What Is a SPIA?
A SPIA is a type of immediate annuity funded with a single, large deposit. Income payments begin within a year of your signing the contract. These payments can last a set amount of time or be guaranteed for your entire life.
While SPIAs are similar to other annuities because they offer a guaranteed paycheck in retirement, they stand out for a couple of reasons. First, they cannot be funded with small installments over years or decades. This means you’ll need a sizable sum saved up to buy a SPIA.
Second, they generally earn lower rates of return because they cannot take on as much market risk as some other annuities. This means you might need to contribute more of your own money upfront to get the same size payment from a SPIA as you would with a deferred annuity.
When to Consider a SPIA
There are a few situations where getting the assurity of a SPIA makes the most sense:
You’re Worried About Outliving Your Income
One of a SPIA’s main advantages is that it ensures a portion of your income is guaranteed for life. That security is important to many retirees.
“Our research shows that individuals are much more confident to spend in retirement when they don’t have to worry about getting an income check each month or running out of money,”says Sri Reddy, Senior Vice President of Retirement and Income Solutions at Principal Financial Group.
One strategy he recommends is setting up a SPIA that generates enough income to cover your non-discretionary expenses, like groceries, insurance, housing costs and other bills you have to pay. That way you’ll always have at least that guaranteed retirement paycheck from a SPIA to cover these expenses. Then you can use other investments or savings to cover nonessential spending, like vacations.
You Don’t Have a Pension
Pensions used to fill the same role as a SPIA as they also generate a retirement paycheck for life. Unfortunately, these defined benefit plans are much less common than they used to be, especially for private sector employees.
With a SPIA, you can turn a part of your savings into your own personal pension plan with the same kind of guaranteed returns. This can be helpful for retirement expense planning.
You’re Worried About Market Risk and Uncertainty
If you keep all your savings in market assets like stocks, there’s always the chance that you face a serious downturn right when you need retirement income. “The timing of investment returns could negatively impact how long the portfolio lasts,” says Dylan Huang, Senior Vice President and Head of Retail Annuities, Investment Solutions and Wealth Planning at New York Life.
“Annuities are a hedge against these investments’ risks so anyone looking for built-in stability in their portfolio would want to consider a SPIA,” says Huang. In fact, because part of your income is guaranteed with a SPIA, you might feel more comfortable being more aggressive with your other investments.
You Need Income Now
Since a SPIA starts making payments to you immediately, these contracts make sense if you need to secure your retirement income payments and lock them in for the long term. This makes SPIAs particularly appealing to recent retirees. With a deferred annuity, you might not see your first payments for decades.
You Want to Generate Income in a Low-Rate Environment
Part of your SPIA return is based on market interest rates you agree to when you sign up. Given that interest rates are very low right now, does that mean you should hold off on purchasing a SPIA? Not necessarily, because SPIAs have an edge over other securities reliant on interest rates: mortality credits. These are bonus payments you get when someone else with a SPIA from your provider dies earlier than expected.
If it sounds strange that you’re getting paid because someone else died, it’s helpful to zoom out on how annuities work in general: To remain profitable and manage the risk of paying out for unexpectedly long lives, annuity companies pool your deposit with those of many other investors. Some will pass away earlier than others, and their annuity balances are retained by the annuity company, which uses the extra funds to pay out higher returns to those who live longer.
Mortality credits are why Huang believes that in a low-rate environment, SPIAs are even more valuable for generating retirement income than other fixed income investments, like bonds and CDs. Since these investments don’t include mortality credits, when interest rates fall, their income payments drop more steeply relative to SPIAs. Huang explained that mortality credits are unique to annuities.
When Not to Consider a SPIA
While SPIAs have several advantages, they aren’t a good fit for everyone. Some situations when they might not make sense include:
You Want to Keep Your Savings Liquid and Accessible
One drawback of buying a SPIA is that once you sign up, it’s difficult and expensive to get your money back. While you may be able to get most of your savings back by forfeiting what’s called a surrender charge, typically 8% or less of your holdings, some purchases are irreversible. This means SPIAs probably aren’t a good fit if you want liquid access to your savings. And even if a SPIA is the right choice for you, this lack of liquidity is a good reminder to consider keeping at least some of your savings in cash or other liquid accounts to prepare for emergencies.
You Already Have Enough Guaranteed Retirement Income
If you’ve got enough guaranteed monthly income, like through pensions and Social Security, you may opt out of SPIAs, says Huang. That’s because regardless of market returns, you’ll have sufficient funds to ride out any downturns.
You Have a Shorter Life Expectancy
If you have a lower life expectancy, due to health issues or family history, you may want to be careful about setting up a SPIA with life payments only. if you pass away within a few years, you might not get all your investment back, and instead of leaving money to heirs, your savings will go to the annuity provider and others’ mortality credits. You can help avoid this by purchasing an annuity with a minimum number of payments, which we’ll cover below, or buying a death benefit rider to pass on unused funds to your loved ones.
You Don’t Need Money Now
Since the SPIA starts paying out income immediately, it holds your funds in more conservative investments and therefore doesn’t grow your savings as much as other annuities. If you still have time until you retire, you may want to consider a deferred fixed or variable annuity to grow your savings more.
Strategies to Get the Most out of Your SPIA
The right strategies for getting the most out of your SPIA depend on your financial goals. You can add on any number of custom rider benefits for an additional cost. Some riders to consider include:
Guaranteed Payments Rider. You can set up a SPIA to make a guaranteed number of payments, even if you die before they’ve all been paid out. For example, you could set it up for life income with guaranteed payments for 10 years. That way, if you die during the first decade of your SPIA, at least some payments will go to your heirs.
Inflation Protection Rider. Over time, prices go up due to inflation, so your original SPIA income payment could lose its buying power. By adding an inflation rider, the payments will increase over time. In exchange, to give your income room to grow, your monthly payments start out smaller than they might be for a SPIA without this rider.
Liquidity Access Rider. Some SPIAs include early access, meaning you could make a partial lump sum withdrawal of your deposit. That way if your plans change, you can get some money back ahead of schedule.
Ultimately, adding riders and other features costs money, which reduces your monthly payment from the SPIA. If your goal is to create the highest possible retirement income for yourself, the best solution may be to forego all the features and focus only on the monthly payout.
Keep in mind, though, that this does introduce the risk that you won’t benefit from the full value of your SPIA or be as well positioned to fend off inflation.
The Bottom Line on SPIAs
If you’re looking for a safe, steady way to generate retirement income, a SPIA is worth considering. SPIAs take the pressure off your investment portfolio and are also one of the few ways to generate guaranteed income for life.
As with any major financial decision, consider meeting with a financial advisor before deciding on a SPIA. “You only get to retire once, so it’s important that retirees seek the help of a trusted financial professional to ensure their goals can be met,” says Huang.