Life insurance agents don't like selling term life insurance for the same reasons that it is the main, and probably only, type of life insurance you should buy. It is a simple, low-cost, low-commission, financial product. Who wants to sell the most boring, lowest-commission product out there? That's like seeing nothing but URIs in clinic all day. If there were a product among annuities similar to term life insurance, it would be a Single Premium Immediate Annuity (SPIA).
What is a Single Premium Immediate Annuity (SPIA)?
A Single Premium Immediate Annuity (SPIA) is a contract with an insurance company where you give them a lump sum of money, and the insurance company pays you a set amount every month for the rest of your life. This ensures you'll never run out of money, and so can be a useful part of retirement planning for many people, particularly those who have barely “enough” or even a little less than “enough.” They are also referred to as immediate payment annuities, income annuities, and immediate annuities. Portfolio withdrawal experts such as Wade Pfau have been recommending them for a long time. Now that most investors don't have a pension from their company, an annuity can take its place in the “three-legged retirement stool” (# 1 Pension, # 2 Social Security, # 3 Savings and Investment portfolio). You're essentially buying yourself a pension with a portion of your portfolio.
What's So Great About SPIAs Compared to the Fancy Annuity My Agent is Trying to Sell Me?
A SPIA is a simple commodity. Just like term life insurance is “pure” insurance, a SPIA is “pure” income. The terms are simple and standardized. Because of this, there are lots of insurance companies out there competing for your business. This competition keeps prices (and agent commissions) lower and provides you a better deal. There are plenty of bells and whistles that can be added on to a SPIA, but every additional feature will cost you a little more. Not only because the insurance company has to pass the cost of it on to you, but also because as the product becomes less standardized, there is less competition for it.
How Much Can You Expect From SPIAs, and What Kind of a Return Will that Probably Be?
This chart demonstrates payout rates and rates of return for a $100K SPIA purchased in January 2021. The last three columns indicate the return on the SPIA as an investment. The return column is your return if you live to your expected life expectancy. The +5 column indicates the return if you live 5 years longer. The -5 column indicates the return if you die 5 years before your expected age.
If you want to know how the chart was created, download this spreadsheet. As you can see, the returns aren't necessarily high (and can easily be negative at today's low yields), although they can still be quite good if you're blessed with longevity. Note that the return is affected much more by interest rates at younger purchasing ages and by longevity at older purchasing ages.) However, a high return isn't the point of a SPIA. The point is that the return is guaranteed. It's an insurance product, and you should buy it for the insurance benefit. You are insuring against the possibility of running out of money due to a long life. In fact, there is some data out there indicating that those who purchase SPIAs actually do live longer, although it is unclear if that is due to a selection bias, less fear about running out of money, or people trying to stick it to the insurance company.
Are There Some Other Benefits of SPIAs I Should Know About?
Part of the SPIA payments are considered by the IRS to be a return of your principal, and thus are tax-free (unless it is inside an IRA, and then it is all taxable income). An annuity is also generally protected from creditors and sometimes isn't counted toward your Medicaid assets when qualifying for Medicaid coverage of nursing home care. It also is not part of your estate (since it is gone at your death) so may even save your estate some taxes, but most people with an estate tax problem don't need annuities anyway since they generally have far more than enough.
What if the Company Goes Under?
One problem with a long-term contract with an insurance company is that you're relying on the insurance company's ability to actually pay decades from now. Insurance companies do, however, go out of business from time to time. Similar to FDIC coverage for bank accounts, most states will cover annuities of up to $100K-300K per person. You can minimize the risk by buying from highly-rated companies, and perhaps by buying several different annuities from several different companies. For example, if you wanted $400K in annuities, but your state guarantee was only $100K, you could buy two policies, one on each spouse, from each of two different companies.
At What Age Should I Buy an Annuity?
Some experts, such as Larry Swedroe, recommend you buy them around age 70. My personal opinion is that you should buy them when you need them. If you're retired at 50, there's nothing wrong with putting some of your money into SPIAs to ensure a “floor” for your retirement income. I wouldn't put it all in SPIAs at that young age, and you can always buy more later. Likewise, if you're 90, and you're afraid of running out of money, a SPIA will keep you from doing that. Plus, at that age, you get huge payments every year (up to 20% of the initial purchase price.) You only have to live 5 years to get your money back. Keep in mind that the number of companies willing to sell you an annuity goes down as you get older than 75.
What About Inflation?
Most SPIAs are fixed, meaning they pay out the same amount each year in nominal dollars. Just like with bond coupon payments, inflation can really eat up a lot of a fixed income. Some people would prefer to buy an inflation-indexed annuity, which like Social Security adjusts each year for inflation. But there are fewer and fewer companies selling them each year (maybe none now), reducing the amount of competition for them. Due to this, some experts like Steve Weisman, recommend against them even if you can find one.
Where Can I Get a Single Premium Immediate Annuity?
The easiest place to get an estimate of what you'd get paid is to look at the free calculator at immediateannuities.com. Since a single premium immediate annuity is an insurance product, you have to buy it from an agent. But just like walking into an agent's office to buy life insurance, know what you want before you walk in lest you be talked into something that is a better deal (for the agent.)
What do you think? Have you purchased a SPIA? Would you recommend it to others? Do you plan to buy one later? Comment below!
Nice post. My mom just got one of these to cover her until her pension kicks in (and beyond).
Judging by the numbers, the best time to buy would likely be 60 or 65 to maximize likelihood of return. Also, you can get a 10 year spouse add on for usually only a few dollars less a month which is well worth it.
I just did some math looking at the 50–>82. So you put in 100k and at age 82 it has grown to 167,360. That comes out to about a 2% growth tax free. Not a terrible product. I mean, it is basically as good as the stock market over the last 12 years accounting for capitol gains tax. The two things that are negative with this product are loss of liquidity, possibility of insurer going out of business, so I would be sure to stay under the limits of the insurance depending on what state you live in. The last kicker is inflation which runs at 3% a year, so this product really is a loser in terms of inflation. If I could have a CPI inflation rider that guarantees a minimum of inflation, this product could be a winner.
They sell inflation-indexed SPIAs. They pay less earlier on and more later on. The market isn’t as competitive, unfortunately. You used to be able to get one through Vanguard. I don’t think they offer it anymore.
https://personal.vanguard.com/us/whatweoffer/annuities/income
The whole point with annuities is mute for me because I’m in my early 30s. But it is an interesting thought experiment
I think Vanguard still offers inflation adjusted immediate annuities. I surfed to this page:
https://www.incomesolutions.com/QuoteAdjOptions.aspx
I hope I am not misleading you.
I don’t see what your link has to do with Vanguard. Am I missing something?
What would your recommend in terms of life insurance if you are in your early 30’s and single? Or would you hold off.
If no one depends on your income, you don’t need life insurance. Perhaps a small policy to cover the costs of administering your estate and burying you, but that’s it. Some people may wish to buy a policy in case they become uninsurable later. I’m not sure I’d recommend that, but you’d have to decide for yourself.
I certainly don’t see any reason to get a permanent policy.
Quote:
“…if you’re 90, and you’re afraid of running out of money, a SPIA will keep you from doing that.”
Just read this back to yourself. 🙂
If you have made it to 90, I think the insurance company would love to take your money.
When I read the phrase “running out of money” I think this means “running out of enough money to live off of,” but truly that is not what you are thinking or you wouldn’t counsel someone to put their last $50,000 (or whatever) into an immediate annuity, thus essentially using up their emergency fund, when there are alternatives that could certainly do better.
I have never known it to be wise to put your last dollars you own into an insurance policy, unless that insurance policy will protect you against “unlimited perils” which clearly this won’t.
fd
I agree it isn’t generally wise to put your last dollars into an insurance policy. I’m not sure I’d take a sentence out of context as a blanket financial advice statement for everyone.
What does a SPIA do? It takes a lump sum and turns it into an income stream from now until your death. If you want that, buy it. If you don’t, don’t buy it. It’s not an appropriate emergency fund, I agree. Whether an emergency fund or a guaranteed monthly stream of income is more useful to a 90 year old, I don’t know. Ideally, it would be nice to have both.
Exactly — it would be nice to have both fixed income and investments. It becomes disheartening to me when people imply as I think you did, that somehow a SPIA is going to protect you from running out of money, or somehow give you more money than you had, when if you look at the mathematics of it, based on the average lifespan, of the “general” population you say you are talking to, it is very much like selling a person an infinite bond with rates about equal to a 10 year bond. This bond has a unique characteristic that it is forfeitable upon death, or continuously renewable for free – if you live beyond your normal lifespan. This is in effect an insurance policy where it only pays off if you outlive the “maturity date,” which for the average person does NOT happen. So why talk like it is such a great deal for everyone. It is basically an insurance policy and we all know who makes the money on an insurance policy, so let’s just agree to not think that both the insurance company and the general public are going to win (translated to mean it is a great investment) when we all should realize that when buying and selling investments both parties can not win!
fd
Insurance is insurance. You buy a SPIA to insure against running out of money due to long life. On average, a group of investors would come out ahead NOT paying the insurance company to do the SPIA and just investing themselves. However, we’re not an average. We only get one shot at this, and if we draw the long straw (for a long life) it might be worth giving a little on the return side in exchange for the guaranteed until death payments. As insurance products go, a SPIA is a great one.
“ Some people may wish to buy a policy in case they become uninsurable later.”
I type this with a long, vertical scar in the middle of my chest.
In general, IF no one depends on you for income, you can choose to not buy life insurance. Things change over time for many people so consider getting a modest term policy while you are young and healthy.
[Unhelpful comment deleted.]
A couple of questions:
1. How does the tax-free “return of principal” look on paper? What tax form is that? Pretty interesting. Does that stop at some point (if you outlive the expected age)?
2. So it is totally kosher to stagger several annuities over time (@45,55, 65… etc)?
3. I have a printout of the rates here and the options (with decreased payouts of course) include spouse survivor, dependent survivor, two dependents. Have you run any kind of analysis if these are worthwhile? Or do you consider it more solid to get one for yourself and another for your spouse (I avoided “wife”!)?
1) Yes, it stops when the principle is gone. It’s just a return of principle, no tax due on it.
2) Sure, but it’s rare for someone to buy one before 60 or so. Most recommend buying on around 70.
3) It depends. In general I like either single life or just on you and your spouse but you really have to run the numbers. It’s possible to be better off to take a single life + a life insurance policy rather than getting it on both of you.
Sounds like you just identified a use for permanent life insurance.
Have you seen this post?
https://www.whitecoatinvestor.com/appropriate-uses-of-permanent-life-insurance/
This reminds me of my neighbor lady who depleted her trust funds in her early 90s. She was the beneficiary of a family trust based in Germany from the 1930s. Knowledge of an annuity may have spared her the misery she lived during her last few years.
Would you be interested in writing an article about private family annuities? Say a reader’s parents are recently retired and now investing conservatively. Is there an easy way the child could invest the parents’ money aggressively (since the child has a lifetime to ride out the ups and downs of the stock market) and pay the parents a monthly amount on par or higher than their conservative returns? Similar to a SPIA where the child acts as the insurance company. That way no money sits in low-return investments and both parties come out on top. What are the benefits, risks, and drawbacks? Legal and tax considerations?
Super interesting idea and another great way that working together between generations can pay real dividends.
The obvious risk is that there isn’t a huge insurance company and a state guaranty association providing the guarantees.
I’d have to do some researching on the legal and tax considerations. Mostly the trick would be using the gifting laws to your advantage.
This really is an interesting idea. Jim, have you looked into this or posted about this? (realizing it’s been almost 4 years since it was suggested).
Not really, other than this post: https://www.whitecoatinvestor.com/building-wealth-across-the-generations/
Do these SPIA’s pay the monthly “income” payment until death regardless of whether the intially invested amount has run out? I.e. if you outlive the life expectancy calculation the company continues to pay your monthly benefit even if there are no “funds” from your investment?
Yes. That’s how they work. If you die the next month, the money is gone. If you live to 113, the money lasts until then.
I own > 1 annuity. Am getting mixed messages about if they are “good for my personal situation”. They are so complex. Hard to decide about taking a hit to get out OR taking the hit and staying in.
Yes, they’re complicated aren’t they. One reason I don’t like them.
I agree that the SPIA that advisors don’t talk about but they should … however term is not necessarily the best option out there.. especially if you want to minimize your risk during the accumulation period.. this post was from 2012 so you might have changed your stance.
I have no idea what you’re talking about, but my stance is still that term life is what is appropriate for most docs and SPIAs can be a useful part of the equation in retirement.
Although more work and more risk, what about taking 200K and buying a rental property, or 300K and buying a couple rental properties instead of a SPIA? Managing the properties might make a good retirement hobby and they could be sold later on in life. I admittedly have no idea about whether the extra risk or tax drag on the investment would be worth the hassle over a SPIA.
I don’t have a problem with investing in income properties. But they are a very different thing than a SPIA. More work, less guarantee, higher return, more variable income etc.
I’m 63 years old. I plan to retire at 66. I already draw a pension from a previous job of $2K monthly. I will draw full social security at 66. I have both IRA & ROTH IRA worth $400K total. 75% is pre-tax.
Do I really need an annuity if I have a pension? Is a 4 legged stool better than a 3 legged stool? 🙂
Do you need it? No. You’ve got a big chunk of your retirement income already annuitized. If you get $24K a year from your pension and another $24K a year from SS, that’s $48K. The IRA and Roth IRA combined can only really provide about another $16K. So you’ve already annuitized 3/4 of your retirement assets. I probably wouldn’t buy another annuity unless you absolutely cannot live on $64K. Even then you’re probably only going to boost it by another $8K or so and you’ll be sacrificing future flexibility and the ability to leave something to heirs for it.
In genera,l normal pensions and annuities are not inflation protected and even SS is becoming less so. That leaves your only inflation protection in your $400k IRA / Roth combo. Depending on your budget that is not a very big retirement nest egg and you can’t really afford to put it in an annuity earning something like a 3% internal rate of return.
Better off buying tax free munis and keeping the 100k for heirs or an emetgency
How does a Charitable Gift Annuity(CGA) compare with the SPIA. CGAs still have the lifetime guarantee, maybe some less monthly $, but a charitable deduction up front and the satisfaction of the money going eventually to a charity rather than an insurance company.
Charitable annuities pay you less because some money is going to the charity. But you do get a tax break for that portion going to the charity. No free lunch, but it can make sense if you’re planning to give to charity anyway.
When trying to wrap my head around these concepts, I found this calculator to be helpful.
https://www.calcxml.com/calculators/how-long-will-my-money-last
The lightbulb for me was realizing that we’re not talking about preserving principle. This is just to show how long a chunk of money will last at a given withdrawal rate and interest rate. Compare to an annuity, and you can see the insurance company calculus. For example an insurance quote I just looked up on immediateannuities.com for $400K at age 65 male is $2200/mo. The calculator shows that $400K today at 4%/year lasts about 21 years at a $2200/mo withdrawal rate.
I imagine that they calculate their “break even” point given your life expectancy at a predetermined interest rate. Then they price it so that they will come out ahead (i.e. they will make money on you) in almost all cases. That’s how “the house” operates. However, in some cases, they will lose money on you (e.g. if you live much longer than the expected or if the market returns are worse than average over the time period).
As Jim says, the income guarantee may be worth ‘paying’ a few percentage points as part of a strategy to put a floor on your retirement income.
Interesting comment that people with annuities may live longer. Essentially, a SPIA is like putting a $400K bet down on the odds that you will live at least 20 years (i.e. age 65-85). If you die soon, that’s a big loss to you (’cause you’re, you know, dead), and to your heirs who lose a big chunk of inheritance money. That could make a good movie plot–evil SPIA agents who “help” their clients make an early exit to pad their bottom line.
I saw an annuity that pays the heir the residual monies left if you die early. Of course, it pays a little less each month. Did I understand this right? Any info/opinion on this type of annuity?
Yes,
The insurance company can write these in all kinds of ways and yes it does change the cost as you might expect. You just have to decide what you want it to do for you and how much you want to pay for that guarantee.
Generally not a fan of these because if the point of buying it in the first place is to get maximum guaranteed income out of it, why would you structure it in a way that didn’t do that?
WCI,
Is there some way I’m not aware of that guarantees you maximum money?
I am of the opinion that no matter how it is structured the insurance company is going to get paid for the risk they take on.
In other words, a larger guarantee is going to cost you more. They are not going to give anything away.
I’m not sure what you’re referring to Dave. You seem to be diving into a lot of my old posts and asking questions about them that leave me guessing what you want to know or discuss and after a half dozen back and forth comments we agree that we agree. Many of these I haven’t written or read for years, including this one.
The benefit of a SPIA is that it provides longevity insurance. You’re guaranteed not to run out of money no matter how long you live. So you can spend the entire check every month and know there will be another next month. Because you are not running sequence of returns risk (and you won’t be leaving any money behind) this generally allows you to spend more than taking a reasonable withdrawal rate from a traditional portfolio, at least until you consider the effects of inflation. Unfortunately, you can’t really get an inflation-adjusted SPIA any more. But I think you know all that, so what are you really asking?
WCI,
It wasn’t I with the original question or comment.
It sounded like OP was just asking about the value of a Period Certain SPIA or Period Certain + Lifetime payouts. where your heirs (or you) at least get a guarantee even if you die in the first year.
Then your comment was “Generally not a fan of these.”
Maybe we are not on the same page as far as what “these” are?? I was just wondering what it was you didn’t like as I see the insurance company offerring you just what you pay for.
I like to split the difference and get a little less lifetime, but be quaranteed a minimum such as:
Life & 10 Year Certain.
Others, which OP could be talking about also give the residual to heirs:
Life with Cash Refund
Life & 5 – 20 Year Certain
5 – 25 Year Period Certain
These are all forms of different SPIA’s that seem to fit different needs. Any one doesn’t seem to offer a better “guarantee” than the other was my only point.
PS: I don’t find these articles they come right to my inbox. 🙂
This one was published in 2012. You need to check your email more frequently. 🙂
Sorry, I thought we were talking about a vanilla SPIA. You know I read these comments in a different place on the website than you do. All of the latest comments from all 1800 posts are aggregated in one place for me so if I don’t go back to the original post and read the other comments I don’t know exactly what you’re referring to.
I don’t like having a “certain” period because it lowers your guaranteed income which is the whole point of buying one of these. I agree it’s all actuarially the same. The company doesn’t care which option you take.
Great post!
Life would be pretty boring if we never made mistakes.
Avoid wrapping an IRA into an annuity. I broke my rule of purchasing something I really didn’t understand.
Annuities (SPIAs) can be a powerful tool as you head into retirement.
From your chart it seems like the SPIA might allow a retiree to actually spend more.
If a 65 year can get almost 6%, this is almost 50% more than the classic sustainable withdrawal rate of 4%.
There’s a fundamental difference — The 4% “sustainable” withdrawal rate is the first year’s withdrawal rate, and is expected to increase every year with inflation. The 6% you mention doesn’t ever increase. Over time this is a significant difference.
I made the same initial mistake. Put in my info (45 years old) and it shows me a 4% return, which got me plenty excited until I thought what that 4% is going to look like in 40 years. Which, with even very low 2% inflation, turns out to be only a 1.8% after 40 years.
Yup, SPIAs ensure you have lifelong income, but if not indexed to inflation, they are very susceptible to it.
Don’t buy them for the high returns or inflation protection, that’s for sure.
DO THE MATH-for joint couple, 20 yr period certain
The Return ior a s minuscule
More chance doing better muni bonds or a balanced portfolio
20 yr rolling periods in equities are quite good; beat bonds 90% of the time
over 30yrs almost 100%
I agree, your return is likely to be higher with traditional investments. That’s not why some people buy them though.
It’s also important to remember that the lack of return of basis at death is why the calculated return is less than the payment rate. It’s totally fine to calculate a rate of return, but one difference from normal investments is that the payments while you’re alive affect you primarily, but the return of basis (or lack thereof) only affects your heirs. For those with no children, have children but you don’t want to give them a lot of inheritance and/or who don’t need an inheritance, who aren’t charitably inclined etc, the lack of return of basis to heirs could be “discounted” to increase the relative value of a SPIA. You could even put a number on it if you want to mathematically model it, for example, by applying a discount factor (say, 50%, 75%, or even 100%) on any traditional investments you don’t spend while you’re alive. This will make the SPIA look much better in comparison.
The flip side is that for those who care a lot about leaving an estate, a SPIA may not be a great choice – you’re basically getting bond-like returns, which I’d expect to underperform a reasonable blended portfolio. I know, you’re also buying insurance, which is an important factor, but it should be weighed against other factors, including estate planning.
Yes, a lot of people are confusing the payout rate (which can be quite high) with the return. I calculated both in this post.
It’s best to think of SPIAs as a way to spend your money, not an investment. If you don’t want the “longevity insurance” aspect of the SPIA, there’s no reason to buy one. That’s the whole point of it. I’m getting hate email from people who think I’m trying to rip them off by publishing this post “pushing” low return investments.