Many annuities carry needlessly high expenses and surrender charges. Additionally their contracts are so complex that most people can’t figure out whether the annuity is a good investment or garbage to be avoided.
While most annuities should be avoided there is one specific type of annuity can be an extremely useful tool for retirement planning.
What’s this annuity? It’s the single premium immediate annuity, or SPIA. A great option if you’re looking to take some of our retirement nest egg and turn it into garmented income for a little piece of mind.
What’s a Single Premium Immediate Annuity?
The single premium immediate lifetime annuity is a contract with an insurance company.
With this contract
- You pay the insurer a sum of money up front
- The insurer promises to pay you a certain amount of money periodically – for example per month – for the rest of your life.
Now with some annuities, the payout is a fixed amount each period. This is known as a single premium immediate fixed annuity.
On the other annuities, their payout is linked to the performance of a mutual fund. This is known as a single premium immediate variable annuity.
It is a good idea to steer clear of variable annuities. They tend to be complex and expensive.
Each also offer different bells and whistles making it confusing and difficult to make accurate comparisons between annuity providers to see which one offers the best deal.
Contrast that with a fixed single premium immediate annuity which help in the following two ways:
- They make retirement planning easier
- They allow for a higher withdrawal rate
The SPIA In Retirement Planning
Fixed SPIAs are predictable and therefore useful to plan a retirement
If you know that you need $X of income each year in retirement, you can go to an online annuity quote provider, put in $X as the payout, check “yes” for inflation adjustments, and you’ll get an answer that tells you exactly the amount you need to purchase that will give you income adjusted for inflation for the rest of your life.
It doesn’t get much easier than that!
You now have a specific figure for the minimum amount of savings necessary to retire safely. Unlike a traditional stock and bond portfolio, there is no guessing.
Single Premium Immediate Annuity Withdrawal Rates
Fixed SPIAs are also helpful because they allow you to retire on less money than you would need with a typical stock/bond portfolio.
How is that possible?
In short, it’s possible because the annuitant cedes the right to keep the money upon death. If you buy a SPIA and die the next day, the money is gone. Your heirs don’t get to keep it — the insurance company does.
The insurance company uses the bull of that money to fund the payouts on SPIAs purchased by people who are still alive.
This essentially means that SPIA purchasers who die before their life expectancy end up funding the retirement of SPIA purchasers who live past their life expectancy.
Annuity Income: Is It Safe?
Financial advisors and financial literature usually refer to annuity income as “guaranteed”, because the income from an annuity is backed by an insurance company. But that doesn’t mean it’s a 100% sure-thing.
Insurance companies can dissolve just like any other company.
While it isn’t common, it’s certainly not impossible, especially given that:
- The longer the annuity period in question, the greater the chance of any given company going out of business
- An annuity is designed to protect you against the risk that you live longer than your money. This is probably a suitably long time.
If you’re careful, the possibility of your annuity provider going out of business doesn’t have to keep you up at night.
Minimizing Your Risk with a Single Premium Immediate Annuity
Annuities can be a very useful tool for minimizing the risk that you’ll run out of money in retirement.
In order to make sure you’ll receive the promised payout, make sure you do the following
- Check the financial strength of the insurance company before purchasing an annuity.
- Know the limit for guarantee association coverage in your state as well as the rules accompanying such coverage.
- Consider diversifying between insurance companies. (Stay belong insurance maximums by having more than one annuity)
- Before moving from one state to another, be sure to check the guarantee association coverage in your new state
A final point about annuitizing – even if your only goal is to maximize your spending power, you may not want to annuitize everything.
Annuities cannot easily be sold. It’s always possible that you’ll be faced with a sudden, large expense.
Therefore it is best to keep a portion of your portfolio in liquid assets: stocks, bonds, cash etc.