The Single Premium Annuity
A single premium annuity is purchased with a one-time payment. Whereas an investor may have the option of purchasing an annuity through monthly contributions to an employer sponsored retirement plan, a single premium annuity is purchased directly from an insurance company or investment advisor. The person buying the annuity, who is known as the annuitant, makes one lump sum payment to the insurance company in order to purchase the annuity contract. The money used to purchase the annuity can either be tax-qualified or tax non-qualified.
Guaranteed Payments by the Insurance Company
In exchange for buying the annuity, the insurance company guarantees that it will make payments to the annuitant for the duration of the contract, whether it begins immediately or at a later date. The length of the contract can be either a predetermined number of years or it can be for the life of the annuitant. It can also be structured to provide income for the original annuitant’s spouse upon his or her death. Depending on the structure of the contract, the insurance company can either begin paying out immediately or at some point in the future. Investors must remember that like any other annuity, once payments begin, the contract cannot be revised and the money used to purchase it cannot be refunded.
Choosing Between Immediate and Deferred Single Premium Annuities
Depending on the financial reasons for purchasing the annuity, an annuitant can choose between an immediate and a deferred annuity. However, a single premium annuity is most often purchased by those who have reached retirement age and are looking for a way to receive guaranteed monthly income.
Single Premium Immediate Annuity
The payout for a single premium immediate annuity (SPIA) begins immediately. For example, if the annuitant chooses to receive monthly payouts, the payouts will begin the month following the purchase. If he or she chooses annual payouts, they will begin the following year.
Retired investors or those beyond the age of 591/2 can purchase an immediate annuity with the proceeds from a qualified plan such as an employer-sponsored 401(k) or a SEP IRA. They can also make the purchase with after-tax dollars from a savings account, inheritance or with capital gains from the sale of stocks, bonds or a home. Investors who are not yet 591/2 are usually advised to purchase a single premium immediate annuity with after-tax dollars. Once distribution begins at a later date, annuities enjoy very favorable tax status, both on the federal and state level.
Single premium immediate annuities purchased with non-qualified money also provide a tax advantage. The majority of the income received from an immediate annuity is tax-free because the lump-sum single premium was from after-tax dollars. Money that grows tax-deferred is also known as “pre-tax dollars”.
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Single Premium Deferred Annuity
Investors aged 591/2 and younger are most likely to purchase a single premium deferred annuity as a transfer from either another qualified account or qualified annuity. This type of transfer, known as a 1035 exchange, must be handled between the two insurance companies or financial institutions. An individual investor cannot receive the proceeds from an annuity sale without paying taxes or penalties.
A single premium deferred annuity usually makes the most sense for investors under the age of 591/2 who are looking to increase their retirement savings but who have already contributed the maximum to qualified plans. The money in a deferred annuity grows tax-deferred until it is withdrawn. At that point, only the interest earned is taxed, as the Internal Revenue Service considers annuity payouts to be the return of principle.
Who is the Typical Single Premium Annuity Investor?
Single premium annuities are suitable for a number of different types of investors. Investors looking to save a substantial amount of money for retirement but who have contributed the maximum amount allowed to their employer-sponsored retirement plans may want to consider a single premium annuity. High-net worth investors can also benefit from tax-deferred growth.
Some states also restrict retirement and annuity savings from frivolous or unwarranted lawsuits. For this reason, those in professions who tend to get sued most often, such as doctors, lawyers, architects, etc., may consider a single premium annuity to shelter a portion of income each year as annuities and life insurance are not calculated as part of an estate during a lawsuit.
Single premium annuities are typically not a wise choice for estate planning purposes. Unless the annuity is purchased with a “period certain” option, which means that payments will continue to a beneficiary should the original annuitant die, the single premium may be lost if the annuitant dies before he or she has collected the original investment. While a period certain option may make sense for some investors, the monthly payouts are usually smaller than they would be without the option, and other estate planning tools may offer a better value.
Investors looking at combination financial and insurance products to help with estate planning may want to compare a single premium annuity with a whole life insurance policy. Both allow immediate access to the single premium, have a cash value component and are advantageous from a tax-treatment standpoint. But, the death benefit of a whole life policy may be less expensive than that of an annuity.
Investors with few assets are sometimes advised to purchase a single premium annuity in order to qualify for Medicaid. Depending on the state, money within an annuity is often “deducted” from the estate when determining whether or not an individual qualifies for Medicaid. This has become a controversial topic and an investor looking to qualify for Medicaid is advised to seek the advice of a financial professional before committing any money to an annuity. Further, most insurance companies advise against this practice.
All investors are reminded that annuities represent a contract. Once entered into, it is usually not possible to for the insurance company to return the initial single premium. The single premium used to purchase the annuity will be retained by the insurance company and returned only as payouts as outlined in the contract.
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