Senior Finances 101: Understanding Annuities, #3

Oct 8th, 2010 | By Sharon Shaw Elrod MSW EdD | Category: Senior Moments Blog

We seniors spook ourselves a lot when it comes to understanding financial matters.  We convinced ourselves the financial world would never make sense to us, so some of us just quit trying.  Here’s a challenge:  read this article about one aspect of senior financial planning, because I’ll bet you will understand it and find it of value.

SCJ started a series on annuities (there are five basic kinds) two days ago.  An annuity is simply a contract between you and an insurance company; what that contract guarantees and requires is the issue we are addressing in this series of articles.  Yesterday we looked at the kind of annuity where you invest a dollar amount (usually over $5000) and then wait for a period of years before you take any money out of the annuity; that’s called a Single Premium Deferred Annuity.

Today we are going to look at the Single Premium Immediate Annuity (SPIA).  This is the kind of annuity that guarantees you a fixed income for the rest of your life, and begins to send you monthly income immediately.  It may even continue after your death, if the contract says that.  However, this is the biggie here:  You have to sign over all the money you invest in the annuity.  The insurance company gets that money to keep; this annuity cannot be surrendered, so you will never be able to touch that money again.  Ever.  

Like the SPDA, there are tax advantages to the SPIA.  For tax purposes, monthly payments are seen as a partial return of principal and thus that part of the payment you receive is not taxable.  And because

you receive part of the principal in the monthly payment, it looks like you are getting a higher rate of return on your investment than you might otherwise see.

Suze Orman says these people might want to buy an SPIA:

  • Those looking for a guaranteed monthly income with some tax benefits;
  • Those who have no beneficiaries to whom to leave their money;
  • Those who need right now a little higher income than just a straight interest bearing investment.
  • Those who want to take advantage of a high interest rate environment. The perfect time to have purchased an immediate annuity, for example, with respect to interest rates, would have been in the eighties, when interest rates were high, not in the late nineties (or now), when interest rates are relatively low

Suze goes on to say this about SPIAs:

“… an SPIA is my least favorite of all investments. Purchasing an SPIA especially in today’s low interest rate environment is not something that I would recommend doing. If interest rates go up, and as of the writing of this book I do not think they can go much further down, you are stuck at these low rates for the rest of your life. The process that we just described, receiving monthly income from an annuity, is known as annuitization, or annuatizing your annuity. What I want you to know is that you do not have to buy an immediate annuity in order to get monthly income from an annuity. You can do so by simply withdrawing money each and every month. This way you are not locked into an interest rate and can have access to your money as well as leave it to your beneficiaries. If for some reason you want to annuitize your annuity (and I cannot imagine why you would) what you need to know is that by definition, all annuities can be annuitized at any time, but please be careful, for some companies are better at facilitating the process than others. How much a company will give you monthly will depend on the actuarial factors and the interest rates that a company uses, so shop around if you ever plan to annuitize.”

We think this is good advice, but as always, be sure to discuss your financial situation with your trusted financial advisor before making any decisions.



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