Dispelling The Myths About
Single Premium Immediate Annuities
As seen California Broker article
April 2001 issue
As the head of a national
marketing organization which specializes in annuities, I spend a good part
of my day speaking with agents around the country. I have found that when
the topic is SPIA’s (Single Premium Immediate Annuities) the level of
understanding as to where the SPIA fits drops. I would like to dispel
certain myths regarding SPIA’s and hopefully bring this product the
respect it deserves. By having a good understanding of how SPIA’s work
and all the payout options available, agents can greatly increase their
sales while providing clients with the benefits they didn’t realize were
available to them. A major feature of the SPIA is the exclusion ratio.
Each payment from an SPIA is composed of both principal and interest. The
portion that represents the principal is excluded from taxation and
received tax free. If a $1000 per month payment has an exclusion ratio of
65% then only $350 per month is subject to tax. A 20% tax payor would pay
just $70.00 per month in tax and receive $930.00 per month after tax. This ratio goes to zero at the point of life expectancy and the entire
amount becomes subject to tax. This on the surface appears to be a
negative event, however, one must realize that what has happened is that
the principal has been all used up and all future payments are all income
and will continue for as long as the annuitant lives. Any other investment
in which principal was exhausted would cease payments. The SPIA
With the baby boomers starting
to reach retirement age, a fresh look at the SPIA is timely. The SPIA
comes in various forms. Following is a list of SPIA payout options
available from most companies.
Life Only - This will produce the
largest amount of income, but payments stop at death
Life with Period Certain - Payout is
made for life, but with some minimum number of years guaranteed (5-50
Life with Cash Refund - A money back
guarantee annuity. Payout is made for life, but if death occurs prior to
payments totaling at least the premium, then a lump sum cash payment is
made. For example, if $100,000 is invested and payments of $1,000 per
month are made for 5 years (60 months) and the annuitant dies, the
beneficiaries will receive a lump sum of $40,000.
Life with an Installment Refund-
Another money back guarantee annuity.
Same as cash refund except the beneficiaries continue to receive the
monthly income until the full premium is paid out. In the above
example, there would be 40 more payments made monthly.
Joint and Survivor - This payout
option guarantees that payments will continue for the lives of both
annuitants. Period certain options can be added. This form is used
primarily with married couples to provide income as long as either one
is alive. Sometimes the benefit drops upon the death of the first or
the primary annuitant. This option produces a higher initial benefit.
Period Certain Only - This option
provides a benefit for a certain period of time, typically 3-50 years
with no life contingency involved.
COLA SPIA - This is a life annuity
with payments that increase or decrease by a set percentage each year.
Initial benefit can be substantially lower than non-COLA annuities.
The greatest concern of senior citizens is
While safety is certainly a concern, the actual answer is “outliving
their money”. This is an important concept for agents. Their senior
clients are worried about having enough money to provide an income
they can’t outlive. The agent has in his arsenal a product which will
guarantee to solve the problem How many times is such a perfect fit
If I die the insurance company keeps all the
The only time this is true is with “life only”
benefit. This payout ends upon death. It has the highest payout
factors and can be a planning tool when the payout is used to fund
life insurance. Upon death the annuity ends, but the life insurance
I suggest to agents that
they offer their clients a money back guarantee SPIA. Basically this
is an SPIA with a refund option. If a client invests $100,000 the
client is guaranteed to receive at least $100,000 back in payouts. Of
course, If they live longer the payout will be more.
Future guaranteed annuity payments will be
decimated by inflation.
Immediate Annuities can be purchased with an annual COLA.
Payments can be increased by 3-7% or more annually compounded.
A mutual fund will outperform an Immediate
Annuity as a source
of retirement income.
A mutual fund might outperform the
Immediate Annuity. I
have no bias against mutual funds. I do, however, feel that clients
looking for retirement income should recognize and evaluate the
risk/reward trade off. If a mutual fund is used to provide income
certain risks must be identified. The following example is one I have
used in agent and client seminars. In looking at the SPIA - mutual
fund comparison we need to make certain assumptions. With the SPIA, a
deposit of $100,000 for a 72 year old male will be about $1,000 per
month for life. To be fair to the mutual fund, I will assume an
annual return of 10% each and every year except one year in which the
fund will drop by 10%. (Some feel this is too generous to the fund.)
Basically with the SPIA the
client receives $1,000 per month for life. If we start with
$100,000 in the fund and withdraw $1,000 per month we would use
$12,000 in the first year. If we also lost 10% ($10,000) we
would find a balance of $78,000 at the at the end of year one.
The client has used 22% of his retirement savings in the first year.
Even though the fund will now earn 10% per year forever, each
withdrawal will further invade principal until it is all used up.
The SPIA also invades principal each month, but once the client’s
principal is exhausted (determined by life expectancy), the insurance
company will continue to make payments for the life of the client, no
matter how many years the client lives.
The issue is whether the
risk of running out of money in later years is a fair trade off to the
reward of perhaps higher payments in the future. I would rather
have deflated dollars than no dollars. I don’t think most agents
nor clients have looked at the risk/reward equation in this way.
Risk is fine as long as the client understands why he is taking that
risk and what reward he can expect for that risk.
If an SPDA is annuitized,
the company will waive surrender charges.
Before a client annuitizes
internally, a comparison should be made. I have seen many situations
where the client would be better off (i.e. getting a higher payout) by
surrendering the Deferred Annuity (actually a 1035 exchange to an
Immediate Annuity) paying the
surrender charge and buying the SPIA from a more competitive
company. If the charge is 3%, but another Immediate Annuity carrier’s rates are
7% better, it pays to exchange. The clients only concern if he wants
to annuitize, is how much his payments will be. The existing
carrier will provide a quote and then we can shop the surrender value
amount to get a competing quote. If the internal annuitization under
the Deferred Annuity is better, the client will accept that approach. If not, he
can 1035 to another Immediate Annuity.
Medicaid Immediate Annuity
In some situations, the purchase
of a restricted SPIA can help an individual to qualify sooner for Medicaid
assistance, and potentially pass on a greater estate to their heirs at
death. In effect, the assets placed in such an annuity are no longer
considered as assets that must be “spent down” prior to Medicaid
eligibility. Then at death any remaining payments are paid to the
beneficiary and may be shielded from Medicaid collection.
Split Annuity (Combo)
A very useful approach is the
Split Annuity. In this structure an SPIA is used to provide income for a
period of years, generally 5-10 years and a multiple year guarantee is
used to get back the original principal in the same number of years. Many
seniors have CD’s on which they withdraw the interest each year. They
want to leave the principal to their heirs. A split annuity can greatly
increase the income side and still guarantee a return of principal at the
end of the term. This idea works so well because most of the income is
received tax free based on the exclusion ratio and the growth side is
helped by the deferral.
Deferred Start Immediate
Sometimes clients want to start
a payment stream at a certain time in the future. An SPIA can be
purchased with a guaranteed payment stream that starts as far out as
perhaps 20 years. This can be a valuable planning tool where a 60 year
old client may want $1,000 per month for life starting at his 65th
birthday. An SPIA can guarantee both the premium and benefit.
Life Insurance and LTC
More and more the SPIA is being
used to fund the premiums on life and LTC policies. Funds in an SPDA can
be exchanged to an SPIA and life insurance purchased to offset taxes on
the built up gains.
I suggest that all agents become
familiar with SPIA’s and their possible uses. The key element is that all
aspects carry the magic word “guarantee”. For conservative clients with
income needs, a guarantee may be exactly what is desired. An income which
can’t be outlived. By shopping many carriers agents can get their clients
the best deals available.
Bob Affronti is president
of FSD Financial Services, Inc. Bob has been in the insurance industry
since 1969. He was a field rep and National Annuity Director for a large
insurance company. FSD is a national annuity marketing firm. Bob can be
reached at FSD Financial Services (800)373-9697 or at