Single Premium Immediate Annuity Guide

Dating back to the beginnings of annuity contracts, the single premium immediate annuity is the simplest, most basic of annuity products. Its uses are many, its drawbacks few – yet today it is overshadowed by its more colorful and complicated relatives, the deferred annuities. It deserves more recognition.

In America, immediate annuities began with the tontines issued by the Equitable Life Assurance Society in the late 1860s. In exchange for a single lump-sum premium, an individual received lifelong payments from the insurance company. As the popularity of this contract grew, it took its name from the payment stream it featured. In financial theory and history, an annuity has long been defined as a series of level payments of indefinite duration – indefinite because they last for the lifetime of the payee. This stream of payments typically replaces the income lost to retirement.

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Annuities are issued by insurance companies because they possess the actuarial expertise needed to calculate the life expectancy of annuity holders. In a single premium immediate annuity contract, the annuity holder makes one lump-sum payment to the insurance company, which agrees to provide income payments on a monthly, quarterly, semi-annual or annual basis. Thus, the first annuity distribution payment will come from one to twelve months after the contract is signed. Meanwhile, the insurance company invests the premium payment so as to generate sufficient income to fund the annuity distributions. The amount of the payments is calibrated to the life expectancy of the holder. The “single premium” designation distinguishes this annuity from its deferred-annuity relatives, which feature smaller, regular payments spread out over years. The word “immediate,” although a very slight misnomer, is useful to distinguish it from its first cousin, the single premium deferred annuity.

Distribution Plans

Unlike deferred annuities, immediate annuities lack an accumulation period for investment funds to grow and compound. Once the initial single premium is deposited with the insurance company, the whole focus turns to the annuity distribution. The simplest of annuity distribution plans is the lifetime annuity. The individual plunks down a lump sum and receives lifelong income payments. At death, the payments cease and any undistributed payments revert to the insurance company. (The insurance company calibrates payments to life expectancy, so overpayments to the long-lived will be compensated by forfeitures from premature deaths.)

Not surprisingly, holders often want value that would have been theirs but for death to be captured by one or more beneficiaries rather than by the insurance company. A death benefit helps to accomplish this goal, albeit at the cost of raising policy expenses and/or lowering the amount of the annuity distribution payments. The minimum benefit would be the amount of undistributed funds, less any partial withdrawals. Another way of dealing with death is by passing along the privilege of annuitization. A period-certain annuity guarantees that the beneficiary will receive annuity payments for a given time period after the holder’s death. A joint-and-survivors annuity continues to pay lifelong annuity benefits to a second annuity holder after the death of the first. A joint-and-life annuity ceases benefits after the first death. An impaired- life annuity anticipates death by adjusting the annuity payment upward to reflect decreased life expectancy.

Most immediate annuity distributions are regular, level payments. Although rare, variable immediate annuities do exist; they tie distributions to the performance of a portfolio of subaccounts similar to mutual funds. The variability of payments reflects the ordinary market variations in portfolio performance. Another, more frequent, departure from the immediate annuity distribution norm is provided by indexed annuities, which are often single premium immediate annuities. Once again, the distributions vary to reflect changes in market performance; this time, it is the performance of the market index (the Standard & Poor’s 500 is a common example) that changes.

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Buyers of the Single Premium Immediate Annuity

Three elements define suitability for ownership of a single premium immediate annuity: possession of the capital sum necessary to support annuity payments, desire for the security of an income that cannot be outlived and desire for payments to commence ASAP. The combination of earlier retirements and increasing life expectancy has swelled the numbers of those meeting these criteria. Among the categories of buyer included are:

  • Retirees converting their life savings – By definition, retirement denotes the absence of earned income. There is no more logical purpose for life savings than to guarantee income support in retirement. Those people who are happy with level payments equivalent to those provided by fixed-income securities are ideal candidates for the single premium immediate annuity.
  • Employees converting pensions and qualified plans – Recent events have spotlighted the risks of relying on company pensions. Converting the pension’s discounted present value to an immediate annuity essentially diversifies the risk (insurance companies hold diversified asset portfolios) and makes it more manageable (insurance companies are evaluated by ratings agencies). In the United Kingdom, pensioners legally must convert to annuities no later than age 75. Many 401(k) accounts are heavily weighted toward the stock of the employee’s company. This lack of diversification actually reflects an intense longing for security; this investment is the only one the employee feels comfortable with because they know it so well. Rolling over the proceeds into a single premium immediate annuity at retirement eliminates the risk of holding all investment eggs in the company basket while delivering the security of guaranteed income for life.
  • Participants in structured legal settlements – Victors in liability lawsuits often recover for lost wages, salaries or entrepreneurial income. Annuity payments are ideal to substitute for this regular income. Consequently, losers are required to buy a single premium immediate annuity in the name of the winner. This eliminates the uncertainty of relying on the loser (who may conceivably be untrustworthy) to make regular payments for years. Note that the buyer of the annuity (here, the loser of the suit) need not be the holder of the annuity (in this case, the winner).
  • Employers wishing to fund defined-benefit plans – Unfunded pension liabilities are continually in the news. One potential solution to this headache is for an employer to purchase a single premium immediate annuity for the employee at retirement. Annuity distributions are identical in character to pension payments.
  • Governments trying to privatize public retirement programs – Governments face industrial-strength problems when striving to keep their public retirement systems solvent. Privatization has been successfully achieved in countries such as Chile with the use of annuities. Single premium immediate annuities have been extremely popular in Chile for over 20 years.

Tax Consequences of the Single Premium Immediate Annuity

Because there is no long accumulation period, the tax-deferred status of annuity investment gains is of uncertain importance with immediate annuities, depending on the length of the distribution period. As with deferred annuities, distributed gains are taxed as ordinary income. Each distribution consists of part return-of-principal, part taxable gain. Because immediate annuities have a higher cost basis, the taxable portion will tend to be smaller than would be the case with deferred annuities, other things equal.

Drawbacks of the Single Premium Immediate Annuity

The drawbacks of the single premium immediate annuity are few and straightforward. One is the lack of flexibility; the holder is surrendering control over a sizable capital sum (perhaps his or her entire wealth) to the insurance company in exchange for the promise of lifetime income security. Although annuity contracts often include provisions to cover emergency contingencies such as health emergencies, there is still the possibility that the need or desire for a sizable sum of money will lead the holder to regret the decision to annuitize. This is the primary tradeoff for the security afforded by the annuity.

A second drawback is that purchase of the single premium immediate annuity requires ownership of a capital sum sufficient to finance a lifetime annuity. This provided the impetus for the creation of the deferred annuity, which allows regular payments and investment over an accumulation period in order to create the necessary capital sum. Indeed, when the accumulation period in a deferred annuity has ended, the contract in effect devolves into an immediate annuity with the accumulated funds serving as the “single premium.”

Regulation of the Single Premium Immediate Annuity

Annuities are issued by insurance companies and are consequently regulated by state insurance departments in almost all states in the U.S. Because most annuities meet the “safe harbor exemption” test laid down for the Securities Law of 1933, they are exempt from federal securities regulation. However, immediate variable annuities and a few immediate indexed annuities are considered securities because the investment risk of the contract is borne by the holder rather than the insurance company. All securities are required to distribute prospectuses to prospective buyers. This disclosure document supplements the information in the annuity contract itself.


The single premium immediate annuity is one of the twin pillars of the annuity structure. While the form is classic in its simplicity, distribution plans can cater to many tastes and circumstances. Potential buyers include retirees, lawsuit participants, employers and governments. The U.S. Social Security system is essentially an inferior version of an immediate annuity; its historic popularity gives a hint of the potential untapped value in the concept of the single premium immediate annuity.

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