Understanding the SPIA
A SPIA is a Single Premium Immediate Annuity contract. These contracts have been designed by insurance companies to provide a guaranteed income stream. Chances are, if you have a pension from your employer, you already have an SPIA. The company most likely purchased an insurance contract that guarantees your monthly income payments for the remainder of your life. SPIAs are one of the most underutilized annuity contracts. The academic world has long sung their praises and the U.S. Government is encouraging retirees to use a portion of their retirement accounts to fund these contracts.
An SPIA insures against an individual outliving his or her retirement income. SPIAs can be structured to provide a guaranteed income for a surviving spouse as well. SPIAs are offered by insurance companies; in a recent interview with a very large insurance company, the insurance company representative said people used to go to insurance companies to help protect against the risk of dying too soon. Now insurance companies are helping to protect against the risk of living too long.
According to a Fidelity Investments report based on the 11 million 401k plans it manages, the average 401k balance dropped 31 percent from the end of 2007 to the end of March 2009. The S&P 500 tumbled 46 percent during that same period. Retirement is all about cash flow, not net worth. If you have a million dollars invested in the S&P 500 and you are pulling money from it for income, and your account drops 46 percent in one year, you will have some sleepless nights. An SPIA, if set up properly, could guarantee between 60-100 percent of your income without having to rely on the stock market. Then when the volatile stock market drops, it won’t be such a shock to your system.
SPIAs are probably underused because they don’t pay a very large commission to the agents who sell them. A bond portfolio, on the other hand, allows for ongoing management fees to generate revenue for the brokers and brokerage firms selling them.
The income you receive from a non-qualified SPIA account is also split by an exclusion ratio. A portion of the money is considered a return of premium and a portion of it is considered taxable interest income. SPIAs are very tax-efficient at creating income, and in today’s interest rate environment, they are much safer than a bond portfolio. Bonds, of course, receive poor tax treatment since the interest income is taxed as ordinary income.
If you are buying bonds for safety and to reduce portfolio volatility, you may want to look at a Fixed Indexed Annuity contract as an alternative because they are safer than bonds and historically have performed equal to or better than bonds. If you are thinking of buying bonds for income, be sure you can hold the bonds until maturity. Be careful with bond funds in a rising interest rate environment like we are in currently; that is the time to consider using an SPIA instead because it is a safer and more tax efficient way to generate the retirement income you need.
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