Single Premium Annuity
Annuities provide retirement income in the form of payments from insurance companies to annuityholders in return for premiums paid to the companies. Annuity contracts specify the amount, frequency and duration of payments from annuityholders to insurance companies. Usually the payments consist of a level stream lasting for years. When there is only one payment, this specific case is referred to as a single premium annuity.
Single Premium Immediate Annuity
The most common type of single premium annuity is the immediate annuity, so called because the return payments from the insurance company, or distributions, begin soon after the sole premium is paid and the contract signed. The interval between signing and initial distribution depends on the payment frequency desired by the annuityholder. For example, election for monthly distributions would mean that the first distribution would occur one month after signing. Annual distributions would delay the first distribution for one year.
Immediate annuities are contrasted with deferred annuities, in which annuityholder contributions to the insurance company accumulate over a substantial time period – usually years – until the distribution date arrives. Although deferred annuities are far more common today, immediate annuities were the original variety, debuting in the nineteenth century as “tontines.”
Immediate annuities and single premiums are natural complements. In the words of an old song, they go together “like love and marriage, a horse and a carriage.”
The Difference Between a Single Premium and Multiple Premium Annuity
The key difference between single and multiple premium annuities is obvious. A single premium must be a sizable sum to support subsequent annuity payments lasting for the remainder of the annuityholder’s life. Multiple premium annuities allow the annuityholder to make smaller contributions that gradually accumulate and grow into a capital sum of the necessary size.
By definition, annuities are retirement-oriented financial instruments. This means that single premium annuities are chosen by recent retirees who have accumulated the requisite financial nest egg. Multiple premium annuities are chosen by younger investors who need to save in order to hatch their egg. Multiple premiums are their regular savings program.
Since annuities are retirement vehicles, immediate annuities are best purchased by those beginning retirement. Retirement implies the absence of earned income, which suggests that retirees cannot afford the luxury of making multiple payments in order to accumulate the necessary capital sum. They must plunk down the full amount in order to start receiving distributions as soon as possible – hence the tie between single premiums and immediate annuities.
Suitable Candidates for a Single Premium Annuity
Most of the candidates for a single premium annuity are purchasers of immediate annuities. Any retiree who has accumulated the necessary funds and wants to guarantee lifetime income fits the bill. It makes sense to build a nest egg using stocks or mutual funds but distribute that wealth from an annuity in retirement. A company employee may well choose to accept a lump-sum payout in preference to a company pension, then purchase an annuity with the payout. This effectively diversifies wealth, rather than concentrating it inside a single company, while preserving the lifetime payout structure of the pension. In the U.K., retirement payout recipients are legally required to transfer the proceeds to an annuity no later than age 75. Governments have used similar logic to privatize social insurance plans using private annuities; Chile is one of the world’s leading issuers of immediate annuities.
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The Single Premium Deferred Annuity
Although the single premium concept melds with the immediate annuity like a hot dog with mustard, it is possible to visualize the single premium annuity in a different context. A young or middle-aged individual of highly conservative temperament who wins a lottery or inherits a sizable lump-sum may wish to purchase an annuity but defer receipt of distributions until retirement. Some companies offer a single premium deferred annuity for just this purpose. Since this choice rejects growth-oriented investments such as stocks and mutual funds, which would usually seem suitable for an individual well short of retirement, it implies that the annuityholder is highly conservative.
The Single Premium Variable Annuity
The other major distinction between annuity types is between fixed and variable annuities. Fixed annuities credit a return to the principal value in the annuity account on a fixed, contractually-stipulated basis. The return can change, but only at stated intervals in ways explained in the contract. Variable annuities allow the return credited to the principal value to fluctuate in accord with market conditions, although there may be upper- and lower-bound limitations placed on permissible fluctuations. Immediate annuities can be had in either of these flavors, although the fixed version is far more common. Most immediate annuities are sold to retirees, whose risk/return profile argues in favor of a fixed-income investment like a fixed annuity rather than a growth-oriented one like a variable annuity. Consequently, the single premium variable annuity is somewhat rare.
The Indexed Annuity
In practice, the indexed annuity is a hybrid type that bears a strong similarity to a fixed immediate annuity. Although the credited interest return fluctuates in accordance with the index, modifications such as the participation rate and annual cap hold down the fluctuations. Insurance features effectively prevent a loss of principal. Thus, the indexed annuity is closer to a fixed annuity than to a variable one. Indexed annuities are often sold to retirees who need some measure of growth with very limited risk. Consequently, they are often packaged as single premium vehicles – after all, retirees don’t earn income to make the regular contributions associated with deferred annuities but do possess the sizable sums necessary to make up a capital sum. The correlation between indexation and a single premium is not complete but it is strong.
The single premium annuity is most often associated with two things: retirement and the immediate annuity. Inherent logic dictates this. Retirees possess the means to acquire the rights to a lifetime stream of payments and the incentive to demand immediate distribution of annuity payments. Other varieties, such as the single premium deferred annuity, the immediate variable annuity and the indexed annuity, also exist to serve more specialized clientele.
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