Single premium immediate annuity (SPIA): Pros, cons & taxes

As you approach retirement, you may wonder whether your savings will cover your expenses for the rest of your life. If you don't have an employer pension or you worry about losing purchasing power to inflation and outliving your nest egg, know that you have options.

A single premium immediate annuity (SPIA), also known as an immediate annuity, is something you can consider if you're looking for a stable monthly income through retirement. SPIAs also offer an option that guarantees you won't outlive your retirement savings.

Here's a closer look at a SPIA, how it works and how to decide if this type of annuity is right for you.

A SPIA is a financial contract between you and an insurance company that can turn your retirement savings into a guaranteed income stream. You agree to pay the insurance company a lump sum of money upfront (the single premium), and the insurance company converts that money into an immediate income stream (an annuity).

SPIAs are one of the simplest types of annuities and tend to be a consumer-friendly choice with easy-to-understand terms. As the name implies, with an immediate annuity, you may receive your guaranteed payment right away, or at least within the first year you buy it.

With a SPIA, you also skip the accumulation period of an annuity, the time—typically during your working years—when you save and potentially grow the value of your annuity to prepare for your retirement needs.

To obtain a SPIA, you work with an insurance company that can convert a sum of money into a permanent stream of income through an annuity. When you purchase the annuity from that company, your insurance agent or financial advisor will help you customize your payment options. You can opt for monthly, quarterly, semiannual or annual payments from the annuity.

You can also choose customized payout options such as life only (lifetime income for one person), joint (payouts cover you and your spouse for as long as you live) or payments structured over a certain period of time. If your annuity has a guaranteed timeframe, it may be able to provide payments to your beneficiaries.

With a SPIA, you can choose how long you will receive annuity payments. The payments can start as soon as 30 days from purchase.

Your contract may include these options:

• Single-life income. Payments will be made for the rest of your life. If you choose life with a guaranteed payment period and die during that period, payments will continue to your beneficiary until the period ends. Single-life income typically provides the largest payments from an annuity.

• Joint-life income. This option provides payment for the rest of your life and your spouse's. If you choose joint life with a guaranteed payment period and both of you die during that time, payments will go to your beneficiaries until the end of the guaranteed period.

• Fixed period. With this option, you can have payments that last as long as 30 years. This option can help you supplement income from a pension, Social Security or other savings for a set period of time.

When it comes to single premium immediate annuities, you should consider your individual financial position, your goals for the future and your investments.

If you're leaning toward a SPIA, here are some pros and cons to consider:

Choosing a SPIA can enhance your retirement strategy, including income for life, tax advantages and customizable payment options.

With any annuity, you can turn your savings into secure, guaranteed income for life. With a SPIA, you're entrusting your savings to an insurance company that promises to pay you an income stream for your retirement. You don't need to worry about investing your money or monitoring the ups and downs of the stock market. The insurance company manages the risks for you and provides you with a steady retirement income payout.

Taxation on the payouts depends on the annuity and how you funded it. If you used tax-deferred savings like a 401(k) or IRA, your full annuity payment may be taxable as ordinary income.¹ If you used after-tax dollars, then a portion of your annuity income will be taxable and a portion will be a non-taxable return of your premium.

Once you purchase an immediate annuity, there are no additional steps you need to take, and there's nothing you need to monitor. You'll receive predictable payments.

Annuities offer customization to suit your financial goals. Do you want to make sure your spouse receives lifetime income too? Do you want to protect your retirement income against inflation? Annuities can be tailored to address your needs. Here are some of the specific options you can choose from:

• Level payments. If you want your payments to remain the same throughout the entire payment period, opt for the level option.

• Fixed-percentage increase. With this option, your payment will increase by the same amount every year (between 1% and 5% annually). This option can be a good choice if you want your payments to increase by a predictable amount.

• CPI-adjusted payments. Under this option, your payments will be adjusted each year for inflation in line with the government's Consumer Price Index.

Along with its many benefits, a SPIA can have some downsides, like low liquidity and inflation risk.

When you purchase a SPIA, you're placing a lump sum of money with an insurance company. Based on the annuity payout you have elected, you may have no access at all to additional money, other than your annuity income stream. If your annuity payout includes a guaranteed period, and you're still within that guaranteed timeframe, you may be able to access additional funds and have your future annuity payments reduced. Taking money out of your annuity or closing it can mean paying penalty costs.

If you opt for a level payout, you risk reduced purchasing power due to inflation.

Annuities may be paid out over a lifetime or have the option to be period certain, which means you choose how many years the payments will last. With this option, if you die before the period is over, the annuity payout will continue to be made to your beneficiary for the rest of the period. However, if you don't have a period certain option, your payments end when you die and your beneficiaries forgo a death benefit from this contract.

Before opting for a SPIA, take your personal financial goals into account. Some questions to consider include:

• What will it cost to maintain your lifestyle in retirement?
• Will your Social Security or pension provide enough income in retirement?
• How will you handle the rising costs of health care?

SPIAs can be a good fit for people who have done their retirement homework and planning. If you have a lump sum of money available to you, a SPIA can help you have an amount paid out to you over time to cover your lifestyle needs. Or, if your needs are already covered by your other retirement safeguards, then a SPIA can set you up with an amount for your retirement wants—regularly traveling or giving to a cause you care about.

Depending on your financial factors, you may want to consider other annuity options—either in place of, or in addition to, a SPIA.

• Deferred annuity.¹ If you're still working and saving, a deferred annuity offers the potential for your principal to grow before you start taking annuity payments. You pay either a lump sum or premiums to the insurer over time, and payments begin at a later date, typically the time you plan to start retirement.
• Deferred income annuity.¹ If you have enough saved to afford the early years of retirement but may need additional money the longer you live, consider a deferred income annuity. It's a type of deferred annuity that provides you with a source of income at a predetermined point in the future, which can be many years away.
• Variable annuity.^1,2 A variable annuity lets you invest your money into a variety of variable investment options called subaccounts. A variable annuity offers a higher potential upside for the growth of your money, and like other annuities, it can provide ongoing income during retirement through withdrawals or the option of guaranteed income payments.