7 Reasons Single Premium Immediate Annuities Are a Poor Choice for Investors

Single Premium Immediate Annuities (SPIAs) offer regular payouts in exchange for a single, upfront payment. You might also hear SPIAs referred to as “income annuities” or “immediate payment annuities.”

Why Investors Purchase Single Premium Immediate Annuities

Seniors who want to supplement their social security income during retirement purchase this type of annuity to ensure that they won’t outlive their savings.

· According to an annuity calculator, a woman at age 65 could pay a lump sum of $200,000 and receive monthly payments of $823 for the rest of her life.

· SPIAs offer very low interest rates and don’t come with the risks of a traditional stock. They often offer higher interest rates than bonds.

· With the right type of contract, SPIAs can also provide an income stream for a spouse after the annuitant’s death.

· Financial advisors sometimes market single premium immediate annuities as an alternative to a traditional pension, as pensions have grown increasingly rare.

Unlike pensions, however, SPIAs have significant drawbacks, and they may not offer as much income protection as investors need.

Top 7 reasons to think twice before purchasing a Single Premium Immediate Annuity

1. You might not live long enough to collect.

If an annuitant dies before they receive the full amount of their principal payment, the insurance company keeps the balance. The money then gets distributed to other annuitants with SPIAs at the insurance company. This is called a “mortality credit.” Obviously, most investors would prefer for that money to pass to their beneficiaries.

2. Beneficiary riders cost money.

You can add a rider with a guaranteed payout period — usually from 10 to 20 years. Beneficiaries added to these policies will continue to receive payments if the annuitant dies before the guaranteed period ends. The drawback? These types of riders add to the cost of a policy that already offers very low returns.

3. You could miss out on potentially better returns.

When the insurance company takes your money, they invest it. Those returns go to the insurance company, and not you. Why should they rake in the profits? Instead of regular payouts, you might be better served by purchasing shares of a reliable, low-risk investment vehicle.

4. Low Liquidity — i.e., no going back.

If you ever change your mind, it’s quite expensive and difficult to get your money out of a SPIA. The insurance company is investing the money you paid upfront — they don’t have it saved and ready for you to access at any time.

5. Inflation poses a hazard to SPIAs.

SPIAs are “fixed rate” annuities, meaning they offer the same low interest rate over the years. But as time goes on, inflation will chip away at the value of the monthly payouts. It is possible to purchase an SPIA that keeps up with inflation, but inflation riders usually mean your initial payouts will be lower, and one analysis by a financial advisor suggests that annuitants that sign up for inflation riders are getting a bad deal.

Consider the monthly payout of $823 for a 65-year-old annuitant in 2021. Will $823 have the same purchasing power in 2051 when she is 95? If the last thirty years of inflation are any indication, her payout will have lost significant value, and it may be all she has left.

6. Are Single Premium Immediate Annuities really guaranteed?

There’s also a risk that insurance companies could default if they become insolvent. It’s rare for insurance companies to have to liquidate, but it is possible, especially during a nationwide financial crisis. Your SPIA is a contract with an insurance company, and you need to review the fine print to find out what happens in the event your insurance company can no longer issue payouts.

7. You still owe taxes.

Keep in mind that the IRS considers payouts from your immediate annuity to be part of your taxable income. At first, only a small percentage of your payout might be taxable, as the IRS will consider the payout to be a return of your principal. After your principal is gone, your payouts can be taxed as regular income. (It is possible to purchase an annuity with income that has already been subject to taxes, which will allow you to avoid owing taxes on your annuity payouts. Examples include money you received from an inheritance, a money market account, mutual fund proceeds, a life insurance settlement, or a certificate of deposit.)

Top Questions to Ask Your Financial Advisor

Discuss your concerns about outliving your savings with your financial advisor. SPIAs are not the only option for replacing a pension. Research what kind of low-risk investments you can purchase now to ensure your nest egg keeps pace with your financial goals during retirement.