Immediate Annuities Aren’t for Everyone

A Single Premium Immediate Annuity (SPIA) can provide a reliable paycheck once a regular paycheck is gone.  SPIAs offer income security that so many American retirees seek and need. However, not everyone needs income security, and not everyone can afford to have it. This article highlights who should buy an SPIA and who should not.

A SPIA provides a consistent income stream that helps pay monthly bills in retirement. You give an insurance company a single lump sum of money and they give you a paycheck for life, or longer, depending on the payout option you select. Annuity income can supplement Social Security benefits, income from investments, and retirement account distributions.

An income supplement in retirement may sound appealing − perhaps too appealing. Many people are buying SPIAs, even those who don’t need them. Make sure you get all the facts and weigh all the options before jumping in.

One problem with SPIAs is that the lump sum given to an insurance company goes away permanently. You can’t undo it. Once you buy an annuity, it’s generally yours for life. Getting that money back is a real problem. I’m not saying it can’t be done, but insurance companies make reversals very difficult and time consuming.

This leads us to the first person who shouldn’t buy a SPIA – one who has little savings. All retirees need some cash on hand for emergencies and unexpected expenses. It’s a mistake to buy an SPIA if you don’t have a lot saved because you can’t get more money if you need it.

Seniors need to be particularly on guard about purchasing SPIAs they can’t afford. It’s well known that the insurance industry isn’t the most ethical on the planet because of the high commissions involved. In my own immediate family, a “Senior Counselor” recommended by the local church sold my in-laws an unsuitable product that used up all their savings and nearly bankrupted them. Luckily, I was able to reverse the contract in time.

The second person who shouldn’t buy a SPIA is someone who has enough income from Social Security, pensions, investments, rents, and other sources to pay their monthly bills. If additional guaranteed income isn’t needed, then a SPIA isn’t needed. It’s really that simple.

Let’s assume that you and your spouse are both 70 years old, have $2 million in savings and you’re spending $96,000 per year in retirement ($8,000 per month). Social Security should cover about $25,000 of your bills, and your investment returns should easily cover the remaining $71,000 per year without any problem. $71,000 is about a 3.5 percent of $2,000,000, and this doesn’t include any income from a pension, business interests, real estate rents, etc. Even if you earn only 2.0 percent per year and take out $71,000 your money will last over 40 years.

People will little in retirement savings shouldn’t buy a SPIA and people with sufficient wealth relative to spending shouldn’t buy one either. So, when does and SPIA come in handy? The answer is if a person has adequate retirement savings, but not enough to cover their expenses for a lifetime.

Let’s assume that you and your spouse are both 70 years old, have $500,000 in savings, are spending $50,000 per year in retirement, and have no pension, real estate income, etc. Now an annuity may make sense. Assume Social Security benefits are $25,000. This leave $25,000 needed from other sources. A joint SPIA that provides $15,000 per year income would cost about $250,000, according to this on-line quote service. This brings the cash generated from Social Security and the SPIA to $40,000, leaving only $10,000 to be generated from the remaining $250,000 in savings. Assuming you earn only a 3.0 percent return on investment, your $250,000 will last more than 45 years. Odds are that neither you nor your spouse will live beyond 115 years old.

I’m not an expert in SPIAs, but Allan Roth, MBA, CPA, CFP® is. Roth is a well known author, financial planner, and the proprietor of Wealth Logic. He says SPIAs can have a place for middle income retirees for the reasons I mentioned earlier, although he does warn of the risks.

Roth’s first concern is a surge in inflation. A fixed income stream using an SPIA could backfire if inflation heats up and there isn’t enough cash-flow down the road to pay bills. Inflation-adjusted annuities are an option, but he notes that the initial income stream from this product is much lower in the early years and may not provide the income needed to pay bills today.

A SPIA is only as good as the insurance company that sells it and that gives Roth concern about default. Each state does insure annuitants, but this insurance is only as good as the state’s ability to pay in the event of a systemic failure across the entire insurance industry. Check the financial strength of the insurance company and make sure you’re familiar with your state’s guarantee program. Roth suggests diversifying SPIA purchases across two or more high-quality insurance companies.

In summary, SPIAs may be a suitable idea for the large segment of retirees who have built modest savings and do not have multiple sources of income. In contrast, people who have little savings should avoid buying an SPIA because they’ll become cash poor. Finally, those who have accumulated greater wealth don’t need an SPIA because they can self-fund their retirement needs.