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Understanding annuities is key for investors in selecting the appropriate investment product for their needs. With differences between interest rates, inheritance rules, and payment immediacy, it’s important for investors to know what their long-term savings goals are and which products can help them get there. A single premium immediate annuity is one option. Learn what it is, how it works, its benefits and disadvantages, and how to know if it’s the right product.
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A single premium immediate annuity is a specific annuity structure. An annuity is an agreement between an investor and an insurance company guaranteeing regular disbursements over a specific period of time after an initial investment. With a single premium immediate annuity, the investor purchases the annuity with a lump-sum payment, also called a premium, and begins receiving payouts immediately.
Single premium immediate annuities are one of the more straightforward annuity products available. They’re often used to fund retirement by providing purchasers with a long-term stream of income after their working years have ended.
How Do Immediate Annuities Work?
The purchaser works with the insurance company to customize the single premium immediate annuity upon purchase. After paying the premium, the purchaser decides how frequently they’d like to receive payments (usually every month, quarter, or year) and the length of time the payments should continue.
Some people choose for payments to continue until the end of their life or their spouse’s life while others elect to include beneficiary protection, ensuring that their children or other heirs receive whatever money remains in the annuity after their death. Another option is setting a specific number of years, such as 10 or 20 years, over which the insurance company will repay the full value of the annuity.
Single Premium Immediate Annuity Rates
Interest rates vary for a single premium immediate annuity. Purchasers can choose a fixed income rate, a varied income rate, or a rate the insurance company adjusts annually to meet inflation.
- Fixed: The insurance company sets a fixed interest rate at the time of purchase that does not change as the purchaser receives payments from their annuity. Fixed annuities are popular as they guarantee a specific payment each month.
- Varied: A varied interest rate depends on stock market trends and can raise or lower as stocks rise and lower. Varied-rate annuities are riskier than fixed-rate annuities but have the potential for more money.
- Adjustable: The insurance company determines the appropriate increase in the interest rate for the annuity depending on inflation. Adjustable annuities offer safety like fixed annuities, but they should meet the demands of inflation.
Purchasing a Single Premium Immediate Annuity
Interested investors can purchase single premium immediate annuities from their insurance company. Investors must purchase this type of annuity with a lump sum rather than a series of payments. Once the annuity is purchased, payments can begin immediately.
Because the government considers annuities income, they’re subject to taxation. How the government taxes single premium annuities depends on where the money comes from. People can place annuity premiums into either the non-qualified category or the qualified category.
Non-qualified annuities use after-tax funding. In this situation, the IRS considers a percentage of each payment to be a return of the initial investment, which was taxed prior to investment. The IRS considers the remaining percentage of the payment to be interest and earnings, which are taxable. Examples of non-qualified funds include:
- Money from a CD.
- Deferred compensation.
- Life insurance payout.
- After-tax savings.
- Money market income.
- Mutual funds.
Qualified annuities use pre-tax money for funding. The IRS applies income tax rates to the full amount of each repayment since they have not yet taxed the money, and they consider it income. Examples of qualified funds include:
- Section 1035 annuity exchanges.
- Section 403(b) tax-sheltered annuities.
- Defined contribution plans from a corporate sponsor.
- Simplified employee pension plans.
Selling a Single Premium Immediate Annuity
Purchasers can sell most single premium immediate annuities if they’re in need of immediate financial assistance greater than the value of their payments. Whether or not the purchaser can sell their single premium immediate annuity depends on where the funds came from to open the annuity. Generally, if the purchaser decided to start the annuity independently as opposed to accepting it as a lawsuit payout or something similar, they should be free to sell it.
Benefits of Single Premium Immediate Annuities
Single premium immediate annuities offer interested investors the following benefits:
- Consistent income: Single premium immediate annuities guarantee payments for a set period of time.
- Lifetime coverage: Purchasers can elect for the payments to continue over their lifetime, ensuring they’ll never run out of money.
- No fees: Single premium immediate annuities rarely have any fees associated with their maintenance.
- Simple maintenance: Once the insurance company establishes the single premium immediate annuity, it requires little to no oversight.
- Cost of living: Purchasers can choose to add a cost-of-living rider to their annuity contract ensuring an increase in the interest rate concurrent with inflation.
- Inheritance: Purchasers can choose to add an inheritance rider to their annuity contract, stipulating that any remaining funds go to a beneficiary after the purchaser’s death.
Disadvantages of Single Premium Immediate Annuities
Interested investors should consider the disadvantages of a single premium immediate annuity, including:
- No flexibility: Once purchased, investors can’t access their money, apart from their disbursements, if they need it. They would need to sell the annuity to a third-party company in order to access their cash.
- Interest rate issues: Investors who purchase a fixed annuity may not have enough money long-term with rising inflation. Additionally, those who select a varied annuity might lose money if the stock market crashes.
- Insurance company health: The safety of the annuity depends wholly on the health of the insurance company. If the insurance company goes out of business, then investors might lose all their money.
- Early death: Investors who die before receiving the full value of their annuity will lose their money unless they’ve elected to purchase an inheritance rider.
Who Should Purchase a Single Premium Immediate Annuity?
Single premium immediate annuities are a great choice for people close to retirement who have a large amount of money sitting in the bank and have already maxed out other retirement accounts like IRAs or 401(k)s.
Investors should take time to research and learn about different retirement products before selecting one. A single premium immediate annuity is one option that might meet the investor’s needs and provide lifelong financial stability.