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How Does a SPIA Work?

How Does a SPIA Work? thumbnail

Today's topic is how does a Single Premium Immediate Annuity work. Some call it SPIA, S-P-I-A, or Single Premium Immediate Annuity. After this blog, you'll be able to decide whether a Single Premium Immediate Annuity fits or doesn't. We're going to cover a lot today about Single Premium Immediate Annuities. I will talk to you about what it actually is, where it started, its brief history, and what it solves. We're also going to go over the limitations and benefits of the product because all annuities have limitations and benefits. Then I'll talk about structuring choices because Single Premium Immediate Annuities are customizable, and I'll talk about the quoting process and how you go about that. And finally, the most important part is where does it fit in your portfolio, or does it even fit at all?

Why SPIAs?

So why would you even want to own a Single Premium Immediate Annuity? It's for income. You only ask two questions for buying any annuity type. What do you want the money to contractually do? And when do you want those contractual guarantees to start? The answer for Single Premium Immediate Annuities is I want income now. I want it to start now. I need a pension. Single Premium Immediate Annuities solve for a lifetime income stream you can never outlive. It will pay. If you live to 150, they'll pay. If there's no money in the account, the annuity companies are on the hook to pay. That's the benefit proposition that only annuities offer. So where does it fit? It fits like it's an income gap filler. It's a pension product. So, think of a Single Premium Immediate Annuity as your personal pension.

The History

How old are Single Premium Immediate Annuities? Very old. They started in Roman times. The word annua, A-N-N-U-A, is Latin for payment. So where did it start? The dutiful Roman soldiers were laying it on the line for the empire, and the Roman government created annuities, a lifetime income stream for them and their families, which is a pretty cool start. They've been around forever. It was the only annuity type sold in this country until the 1950s. Single Premium Immediate Annuities, providing a pension plan for you, a personal pension plan, have been around for a long time.

What Does It Solve?

What does Single Premium Immediate Annuity solve for? They solve for lifetime income. You can never outlive it. Return on investment is whatever it talks about. What's my return on investment? With a Single Premium Immediate Annuity, I always say, "There's no ROI till you die." We don't know because it will pay you for the rest of your life. If you set it up joint with your spouse, and if you die, the income stream will continue uninterrupted and unchanged for your spouse. So, think of it as a pension. Think of it as an addition to Social Security. It's an income gap filler. If you need a specific amount in addition to Social Security or a pension if you're so fortunate to have one, that's what a Single Premium Immediate Annuity solves for.

Client Example

A few years ago, I set up a Single Premium Immediate Annuity for a husband and wife, and the husband was worried that the wife was not involved in investing. She didn't care much about the market, but she just wanted income. Obviously, that was important to her. So, we set up a Single Premium Immediate Annuity, joint life, and guaranteed that all the money would go to the beneficiaries if something happened to them. But he passed away. I get a call from her, and she says, "Stan, is that income stream that me and Jack got, is that still going to continue?" And I said, "Absolutely. It will continue uninterrupted and unchanged for your life, and understand that if you pass away, whatever money's left, it will go to your grandchildren." Let me tell you something; she was pretty happy about that.

SPIA Benefits

Let's go through the benefits. First of all, it's a contract. It's a contractual guarantee for the rest of your life. You can never outlive it. Another benefit is that SPIAs are customizable. You can structure it any way you want. There are over 30 ways to do that. You have to be specific about how you want the money to work. Also, Single Premium Immediate Annuities provide the highest contractual guaranteed lifetime income stream of any annuity product. There are no annual fees, they're easy to understand, and they're a transfer of risk. You're transferring the risk to the annuity company to pay you for the rest of your life. And they can be used in IRAs, non-IRAs, and Roth IRAs.

Let's talk about using it in an IRA. Inside an IRA, the income stream from a Single Premium Immediate Annuity is taxable at ordinary income levels like any money from an IRA. But if you use it outside of an IRA, in what's called a non-qualified account, a non-IRA account, a Single Premium Immediate Annuity income stream is a combination of return of principal plus interest. So outside of an IRA, you won't pay taxes on the principal. You're only going to pay taxes on the interest. That's favorable to you. Let's say you're getting $3,000 a month, it might be that $800 of that $3,000 is taxable. Obviously, if you use it in a Roth IRA, 100% of that income stream is not taxable.

Limitations of SPIAs

Let's talk about the limitations of a Single Premium Immediate Annuity. This is very important. You need to know that before you make a buying decision. Number one, they're very rigid. It's a rigid contract. Think of a water faucet. You rip the knob off a water faucet; the water's just flowing. Once the income stream starts with an Immediate Annuity, you can't stop it. It's an irrevocable contract. That's good, but that is a limitation that you need to be aware of. The good part is you're going to get a lifetime income stream. It is a rigid contract, and there's no market-type growth. There's a loss of opportunity. So, you have to allocate the money, and it has to be in proportion that fits your specific situation. You don't want to put too much money into an Immediate Annuity. What you want to do is solve the income gap that you need contractually.

I recently talked to a gentleman, and he said, "Hey Stan, I want to put this lump sum," and it was a big lump sum, "into Immediate Annuities." And I said, "Well, tell me about what you're trying to solve for. What do you want the money to contractually do, and when do you want the contractual guarantees to start?" And I concluded he didn't need to put all that money in there. Keep a lot of the money in the markets, and keep a lot of the money in growth-type vehicles. And so, what we did is we solved for a specific income amount using as little amount of money as possible. We reverse-engineered the quote to solve for that monthly guarantee that he needed. He walked away pretty happy because he kept much of his money in the markets and in growth, yet he solved for that income guarantee. He realized he could spend less money to solve his specific goal.

Structuring a SPIA

Let's go over how you structure a Single Premium Immediate Annuity. Understand that it's customizable. You need to tell me exactly how you want the money to work, and I'll let you know the structuring we need to do. It might be just your life, and it might be joint life with a spouse. It might be a period certain or for a specific period of time, or it might be a combination of the two. Understand that life-only is the highest contractual payout, but when you die, money goes poof. But understand that most people don't structure it that way. Some do. The annuity company is on the hook. You have transferred the risk to them to pay you for the rest of your life, regardless of how long you live. But when you die, 100% of the money goes to your beneficiaries. That happens in joint life. We can set it up so that when you die or the first spouse dies, the second spouse gets the money to continue, payment-wise, uninterrupted and unchanged for their life. And when they pass, 100% of the money goes to the beneficiaries. We can structure it exactly how you want us to structure it. If you want increases to the income stream, understand that the annuity company will lower the initial payout if you attach that Cost of Living Adjustment, COLA, and rider. And that's okay. I would encourage you to look at both quotes.

Let me give you a good story about that. A guy called me the other day, his name was Frank, and he said, "Stan, I want an increase like Social Security." Social Security increases your income. What I told him is annuity companies; they price that in, and they don't give anything away. They have the big buildings for a reason, right? So, I showed him both quotes. I showed him the Single Premium Immediate Annuity with a COLA and without. And I'll tell you what he did; many people do this. He bought one of each. He split the money. Part of the money was getting a static payment, and the other part was getting an increase. And he walked away pretty happy because he got the best of both worlds. He got the highest contractual guarantee without the COLA, and then he had the COLA increase to his income stream in case he lived forever. He's just playing the transfer risk against the annuity company.

SPIA Quotes

Let's talk about the quoting process of an Immediate Annuity. If you can, think about buying a plane ticket. When you buy a plane ticket, like if you go to one of those aggregate sites, you punch in the number. You say, "Here's where I want to go." You don't know which carrier it's going to be; you know which airline. Same thing with Single Premium Immediate Annuities. It's a commodity. There's not one that's better than the other. And think of it like this. When you go buy a gallon of milk at the store, seven to 10 days later, that gallon of milk is going to expire. You got to get in another gallon of milkā€”same thing with an Immediate Annuity quote. When you quote a Single Premium Immediate Annuity every seven to 10 days, if you don't decide, you have to requote it. So, understand it's a commodity. The quotes change, and carriers at the top change. There's not one that's better than the other. You have to quote all carriers.

Let me tell you a recent story about quoting with a client of mine. So, he had been quoting a lot through us. And when we quote, we send you the information. We leave you alone. We don't pester you. But he kept quoting and kept quoting, and he came back about 14 days later after quoting and said, "That's the one I want, Stan, that carrier right there." And I said, "We can't do that because it's expired." I told him, "Remember, it's like a gallon of milk, seven to 10 days." So, we had to requote the exact same parameters so he could lock in that quote. And fortunately for him, when we requoted the numbers, they were higher. But that doesn't always happen. If you get a quote and like it, you have to move on it. That's not a sales pitch. That's just the reality of how you quote Single Premium Immediate Annuities and the fact that they expire.

Where Do SPIAs Fit?

Finally, let's discuss where Single Premium Immediate Annuities fit in your portfolio. You have a portfolio of stocks and bonds, 401(k), etc., so where do Immediate Annuities fit? They fit for pension income. If you need income right now, that's where it fits. It's an income gap filler. You can come to me and say, "I have X amount lump sum. How much guaranteed income can I get through a Single Premium Immediate Annuity?" Or we could reverse-engineer the quote. "Hey, Stan, I need X amount per month. How much premium will it take?" But it's a gap filler. And you need to make sure that you're putting only a little money into Single Premium Immediate Annuities and solving for a specific contractual guarantee you're trying to achieve.

Never forget to live in reality, not the dream, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.


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