New Retirement Investing Trend: SPIA What you and your spouse should know about SPIAs. BY CRAIG E. HEMKE
You can be sitting pretty during retirement with the proper investments.
As couples struggle with the complex challenges of retirement income planning, more are turning to Single Premium Immediate Annuities, or SPIAs for help in managing the risk of outliving their retirement assets. In short, an immediate annuity allows a person to convert a sum of money into a guaranteed series of payments for a period equal to the greater of the person's life or a certain number of years.
SPIA sales have been relatively flat for years, however sales have recently been growing at a 25 to 30 percent annual rate, reaching $2.4 billion in 2008. This demand and growth will most likely continue for the foreseeable future.
By now, most Americans are familiar with the risks inherent to investing. Market risk, inflation risk, interest rate risk are all items that investors have grown accustomed to managing. These risks are still present for the retired investor, but they are joined by a new risk—longevity—which is the possibility that you might outlive your assets. An investment in a SPIA is one of the few steps an investor can take to manage this risk.
Longevity risk is often misunderstood. Though many have seen articles and studies on life expectancy, longevity is something completely different. Life expectancy is defined by the expected life span of a person born today. That life span is often limited by childhood illness, disease and accidents. Longevity is defined by the average lifespan of someone who has already survived to age 65 and thus has a much longer expected life span.
In fact, current actuarial tables indicate that a healthy 65-year-old married couple has a 50 percent chance that one person will survive all the way to age 92. There’s even a 25 percent likelihood that one person will make it to 97! Stocks, bonds and certificates of deposit are all helpful investment tools for the average retiree, but none of these investments can truly guarantee income for 30-40 years of retirement. However, an immediate annuity can.
How Does an Immediate Annuity Work?
In exchange for a single, lump-sum investment or premium payment, an insurance company will guarantee an investor a fixed income payment for life. Similar to a defined-benefit or pension plan, this income is steady, predictable and guaranteed by the insurance company to continue for the entire lifetime of the investor. The frequency of the payments is determined by the investor as well and payments may be received monthly, quarterly or annually. The investor may also decide the level of beneficiary protection they would like. These options include:
1. Life or Joint Life Only: With this option, payments are guaranteed to the investor for as long as they and their spouse live. However, once the surviving spouse passes away, the income payments stop and nothing is paid to beneficiaries.
2. Life or Joint Life with Period Certain: This option also guarantees income for life, but it includes some beneficiary protection. Let’s say, for example, an investor purchases a Joint Life with 20-Year Period Certain contract and then the investor and their spouse both pass away after only receiving 10 years of income. In this case, the stated beneficiaries of the contract will receive the remaining 10 years of guaranteed income, thereby fulfilling the contract’s 20-year income component.
3. Life or Joint Life with Cash Refund: This option guarantees income for life too, but comes with a different form of beneficiary protection. In this example, let’s say an investor purchases a Joint Life with Cash Refund contract for $200,000. Then, both spouses pass away after receiving just $50,000 in income. With this contract, the insurance company will return or "refund" the $150,000 difference to the contract’s stated beneficiaries.
Other annuitization options are available but the three listed above are, by far, the most popular.
Besides guaranteed lifetime income, SPIAs have other advantages too. Most prominently, SPIAs can have tax advantages when purchased with non-qualified or after-tax dollars. Depending on the age of the owner, income from a SPIA can be as much as 70 percent tax-free because a significant portion of your income each month is considered a tax-free return of principal. For those in high tax brackets or those who fear higher future tax rates, this tax-free component can be quite attractive.
Combining these factors it’s easy to see why SPIAs are the fastest growing segment of the annuity market. With more Baby Boomers retiring every year and with continued product innovation and tax rate hikes, it’s also quite likely that this trend will continue for many years to come.
Craig Hemke is a twenty-year securities and insurance industry veteran. He founded BuyaPension.com, an online sales site for individuals looking to research and purchase single premium immediate annuities, in 2008.