It sounds too good to be true: You give an insurance company a sum of money, and they promise to give you a check for as long as you live.
This is what’s called a “single premium immediate annuity” (SPIA). It’s essentially a form of insurance.
To the recipient, it works like an employer pension plan. When you retire, the SPIA, (technically, the insurance company) pays you a set amount per month for life. Or, in some cases, as long as you and/or your spouse live.
How can they do that? The obvious question is “How can a company afford to do that?” After all, some people live a LONG time.
I spoke with a client recently who is in his early 90s. His beloved grandmother lived to be 102. She was born in 1854…meaning she lived through the American Civil War!
Insurance companies don’t fret over clients who live a long time. They know if you gather a large enough group of people, you can reliably calculate how many of them will live to a good old age, die early, or reach average life expectancy.
In other words, when an insurance company calculates SPIA payments, it isn’t thinking of one person, but thousands.
How SPIAs work. Retirement is when workers need to turn their 401(k) and IRA assets into income. SPIAs can be an option that provides certainty unavailable from the stock and bond markets, which are often volatile.
Here’s an example: Janet Jones is about to retire at 65. She stands to get about $1,000 from Social Security each month. She knows she can’t make it on $1,000 per month, but fortunately she has $250,000 in retirement savings. If she were to withdraw a conservative 3% of her savings annually (i.e., $7,500) that would pay her $625 per month.
Janet knows she can’t make ends meet on $1,625 per month! She also remembers some negative investing experiences. She’s scared to put all her assets into the stock market—and try to live off the profit. What if the market goes south for an extended period?
After hearing about the SPIA option, Janet finds an insurance company willing to take her savings and guarantee her $1,405 per month for as long as she lives.
This sounds great until Janet wonders, “What if I die early? Suppose I only get two checks for $1,405 and then I die? The insurance company would have taken my $250,000 and given me only $2,810. No thanks!”
Other options.
Janet has some other options.
If she agrees to take a lesser amount—$1,379 per month for life—she can get a guarantee that if she dies before ten years are up, a beneficiary named by Janet will get the remainder of those $1,379 monthly payments until ten-years’ worth of payments are made.
That guarantee means Janet and/or her beneficiary will receive at least $165,480 worth of payments. And if Janet lives to age 102 like my client’s grandmother, she’ll ultimately get over $600,000.
Janet could also choose another option that promises to pay $1,260 per month for as long as either she or her spouse is alive.
A few caveats:
- Understand, when you buy a SPIA, your money is gone to the insurance company—you’ll never get that lump sum back. What you will get back is a guarantee that as long as you are alive (or possibly longer, depending on the option you choose), you or your spouse will receive an income.
- All of the numbers here are from a single, middle-of-the-road insurance company. Remember: It’s the insurance company that guarantees a certain income, not a government entity.
- Understand, your SPIA’s monthly payments will not be increasing (unless you pay extra for the privilege), so inflation may present a problem.
- Always work with a financial pro and shop around for the best deal.
SPIAs can be an important piece of the retirement income puzzle for many Baby Boomers. But it should not be the only piece, and they aren’t right for everyone.
But if you find yourself short on dollars and safe options, you should at least give a SPIA a close look.
Columns like this trigger lots of financial questions. Make sure you’re asking all the right ones. Email me at bmoore@argentadvisors.com and I’ll send you my free list of “30-Something Questions for People Who are 60-Something.”
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