What are Annuities? An Introduction to Immediate Annuities

What are Annuities? An Introduction to Immediate Annuities

Tree of Money

Understanding Annuities makes it easier for you to make an informed decision rather than just listening to an advisor or worse a talking head on television.  Annuities often bring up strong emotions when they really shouldn’t, it is nothing more than a financial product often issued by insurance companies.  The definition of an annuity is simple and straight forward, but like anything else when you dive deeper it gets a little more complicated.

The definition an annuity is nothing more than a stream of income for a fixed period of time.

If that is the definition what is the easiest type of an Annuity to Understand? The SPIA

What is a Single Premium Immediate Annuity?

So I have a lump sum of cash, but I am freaked out that I don’t want to worry about investment returns I just want a stream of income.

Well then you would buy a SPIA, a Single Premium Immediate Annuity, for life.  So we are going to get a stream of income for the rest of your life.  If you die (or 2 people die if it is a joint product – more about this below) then the income stream is over.  You are making a bet with an insurance company that you are going to live a long time.  You would never buy a SPIA if you are on your death bed.

The payout is based on your age and current interest rates.  So all those people that bought SPIAs when the interest rates were at 5, 6 or 10% are laughing all the way to the bank for the past decade.

How Can we Alter a SPIA?

Did you make a face at that part when I said, if you die the stream stops? Well, if you did then you can add a rider to your product so it is guaranteed to pay you (or your family) for a certain time period.  So if you have a 10 year SPIA you will get an income stream for 10 years, but if you die in year 7, your family will get the remaining 3 payments.  This differentiates it from the plain old vanilla SPIA.

What if you it is a couple’s money, and you want to make sure that the lump sum that we talked about in the plain old vanilla but you want it to last 2 lifetimes (usually a husband and wife)?  You can buy a joint IRA and you can guarantee a stream of income for both spouses.

Should I Buy a Single Premium Immediate Annuity?

A SPIA is a financial product like any other, and you need to apply it to your situation.  If you have a lump sum that you want to turn into a guaranteed income stream, then Yes a SPIA is for you.  If you want to take yourself out of the market but want more than 1% than a savings account, then a SPIA is for you.

If you have knowledge of your pending close death (i.e. you have already been diagnosed with terminable cancer) then a SPIA is not for you.  If you have a general distrust for the insurance industry and you don’t have an open mind then a SPIA is not for you.

An Example of a SPIA

Lets make things real.  I am using a ~150 year old very good rated insurance company (think cream of the crop not your mom and pop insurance company).

  • 70 year old male
  • $100,000 Lump Sum
  • Plain Vanilla SPIA

Provides about $8,200/yr for the rest of that male’s life – this doesn’t matter what the market does.

Next up: Deferred Annuities

Do you own a SPIA? Ever been approached to buy one?

9 Responses to What are Annuities? An Introduction to Immediate Annuities

  1. i find these annuities too much of a risky investment because there are very few things that you can use in your due diligence

    • Unless you are saying that you don’t know if the company will be around long enough to pay you out, I don’t think you understand the product then.

  2. Wow, that was the simplest definition of an annuity ive seen. the pros and cons were also well stated, thank you

  3. Great article! Where annuities get a bad rap is when someone buys one with a bad company. It is not a “risky investment,” because an annuity is not the investment-there are funds within it that you can choose based on your risk tolerance. However, an annuity IS an insurance product, and should be bought from a very highly rated, reliable insurer. (See Northwestern Mutual, Guardian, New York Life, etc).

  4. So what are the ideal conditions – only appropriate for older individuals, big family, etc?

    BTW – your email was hilarious. I don’t think you’re always on, just figured my emails got sent direct to some special mailbox you could answer immediately…

    like the bat phone :)

  5. based on the fact that if you die the money is gone, is reason enough for me to keep my cash and do with it as i please. i would not want to have someone else (an insurance company) getting my money.

  6. Most companies offer a cash refund option where the balance (deposit minus withdrawals/income) is paid to a beneficiary. This lowers the income slightly but should remove any concerns for those worried about premature death.

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