SPIA – A Good Annuity
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What is a SPIA?
A SPIA (Single Premium Immediate Annuity) 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 just about anyone. 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” (Pension, social security, savings/investment portfolio). You’re essentially buying yourself a pension with a portion of your portfolio.
How much can you expect from a SPIA, and what kind of a return will that probably be?
This chart demonstrates payout rates and rates of return for a $100K SPIA purchased today. 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.
As you can see, the returns aren’t necessarily high, although they can be quite good if you’re blessed with longevity. But a high return isn’t the point of these things. The point is that the return is guaranteed. It’s an insurance product, and you should buy it for the insurance benefit. You’re insuring against the possibility of a long life. In fact, I wouldn’t be surprised to see data that indicated that those who purchase SPIAs actually live longer.
Are there some other benefits of a SPIA I should know about?
Part of the SPIA payments are considered by the IRS as a return of your principal, and thus are tax-free. 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 save your estate some taxes.
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 like to buy an inflation-indexed annuity, which like Social Security adjusts each year for inflation. But there are fewer companies selling them (making them more expensive), so some experts, like Steve Weisman, recommend against them. My recommended strategy is to avoid annuitizing your retirement stash all at once. Then, if you find you need more income after enduring 10 years of inflation, you can just annuitize another chunk of the portfolio. Hopefully having some of the portfolio still invested in assets expected to beat inflation, such as stocks or TIPS, will mean that you still have something left to buy that 2nd (or 3rd) annuity with.