Single-Premium Deferred Annuities (SPDA)

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retired couple that just purchased a single premium deferred annuity
Cheerful senior couple having fun in the park. Focus is on woman. Copy space.

A deferred annuity (DA) is an insurance product designed to generate a source of income for retirement. The investment deposits are made on a one-time or recurring basis to the annuity company. The deposits are held for at least a year, and the investor receives augmented repayments in return. Opting for deferred annuity insurance is akin to planting a tree today (investment) and eating its fruit (deferred income) for the rest of one’s life after retirement depending upon the type of insurance. In this article, we will learn what a single premium deferred annuity is, how the contract works and what might make sense for your financial situation

Introduction – SPDA

An SPDA requires the purchaser to make a one-time payment from his savings or retirement plan (i.e., 401(k)). The investment keeps growing to provide a stream of income post-retirement.  The deferred annuity plans (DAPs) are helpful for employees approaching their retirement. They are expected to have built some savings for investment in the DAP. It merits mentioning that if a tax-advantaged income makes an investment in DAP, the income received from DAPs shall most likely be taxed because the input stream of money for the annuity plan is not taxed before. The SPDA plan is suitable for those who: 

  • Make the entire premium payment in a lump sum to avoid the hassle of recurring payments,
  • Aspire for a secured financial status after retirement based on a steady accumulation of interest on a tax-deferred basis,
  • Intend to make good use of guaranteed minimum interest rate,
  • Want to take advantage of the bonus interest feature. Generally, the repayments in a deferred annuity are received post-retirement. However, there is always an option to start receiving the repayments before retirement. 

How Does SPDA Work?

The SPDA works just like most other annuity plans. The annuitant makes a one-time premium payment to the chosen annuity company. There is another option of making payments in smaller amounts spanning over a few months or years. The annuity company invests this money according to the strategy and plan chosen by the annuitant. The accumulated interest (competitive rate of return) is tax-deferred. The annuitant doesn’t have to pay any taxes as long as he doesn’t opt to withdraw money from the annuity plan. Generally, the annuitant can start withdrawing from the SPDA one year after the subscription of the plan.

Let’s take an example to understand SPDA better.

Mr. Anthony, a male 60 years old and his spouse is 55. He has a corpus of $200,000 to invest and is looking for a lifetime income stream. He enrolls into an SPDA and will start receiving annual payouts beginning 10 years from now (when he is 70 years old).

His payments will look like the following (we have taken average rates as of 2021 for simplification)

Plan TypeAnnual Payout Rate (after 10 years)Annual Payout (in $) (after 10 years)
Single Man LifeBetween 9.20 %- 9.50%$18,400 – $19,000
Single Woman LifeBetween 8.50% – 8.75%$17,000 – $17,500
Joint Life with period certainBetween 7.05% – 7.30%$14,100 – $14,600
Approximate Payout in a typical SPDA

Contrary to SPDA, the single premium immediate annuity (SPIA) offers immediate withdrawals. However, the rate of return, in this case, is lower, and the first-time premium payment is also very high. The annuitants opting for SPIA don’t need to wait for a whole year to receive the repayments. The SPDA has an added advantage over SPIA of tax-deferred accumulation of interest until the start of annuitization. In comparison to SPDA, another annuity contract called flexible premium deferred annuity (FPDA) features multiple-segmented payments after the initial premium by the annuitant during the accumulation phase.

The annuitant opting for SPDA can choose the time period (called a Term), say 20 years or one’s entire life, for the receipt of deferred annuity payments. Based on the chosen term, available balance, and the payment plan, the annuity company calculates the monthly payout for the annuitant. The amount of monthly payout also depends on the total span of payments made to the annuity company. The longer this span, the lower the monthly payout after the accumulation period. The annuitants can take advantage of SPDA in two ways; 

  • By simply annuitizing to create an income stream, and 
  • By purchasing the guaranteed withdrawal benefit (GWB), they can access the cash value of the annuity plan while still having a lifelong stream of income.    

Advantages of SPDA

The SPDA is an investment plan designed for those individuals who have funds in excess of their day-to-day needs and they want to invest the lump sum amount for a steady stream of income. These are the annuitants who can afford to wait for a long time to get their annuity plan mature for the withdrawals. Various modes of investment are used in the annuity firm such as cash savings, lottery winning, stock sale, bonus, inheritance, or tax refund.

SPDA has many advantages over other annuity plans and the conventional vehicles of investment such as saving accounts detailed as under.

  • A tax-deferred interest income is received before the commencement of annuitization. Hence, the assets keep soaring without paying the taxes unlike a taxable brokerage account or a cash deposit that is taxable every year.
  • The fixed interest feature of SPDA makes it attractive as a reliable source of income post-retirement. SPDA helps cover the essential expenses while heading towards the retirement age while supplementing pension and social security incomes. 
  • The SPDA operates both ways, that is, with the provision of a guaranteed rate of interest, and a rate based on the stock market index. When the stock exchange is up, the annuitant returns are determined based on a fixed formula. However, the annuitant doesn’t lose anything when the market is down. This indicates that an SPDA annuitant has the option to limit their investment downside while compromising a tiny part of the upside. Hence, the downside protection is ensured by the SPDA plan while sacrificing only a slight part of the upside.
  • A range of available deferred annuity plans enables the annuitants to choose a plan that best suits them based on their objectives and extent of risk tolerance.
  • Unlike the conventional saving vehicles such as 401(k) or individual retirement account (IRA) that are bound by a saving limit, the deferred annuities do not have contribution limits and, therefore, are attributed as powerful annuity plans.
  • The deferred annuity plans are complemented by extra benefits such as guaranteed minimum payment post annuitization despite a poor investment performance. In addition, death benefits are offered to heirs in case of the annuitant’s death during the accumulation phase. 

Disadvantages of SPDA

Talking about the SPDAs, it appears a bad choice particularly in case of serious health issues that threaten life expectancy. SPDA may not be able to support the annuitant’s medical expenses. And if SPDA is not complemented by beneficiary protection rider, this annuity is useless for the heirs of an annuitant. In addition to the aforementioned, the following are some disadvantages of the deferred annuities: 

  • Surrender charges may apply for repayment claims before the schedule. In addition, the decision cannot be revoked once the annuitant starts receiving the repayments before schedule. So, it’s costly and is characterized by poor liquidity character.
  • An early withdrawal penalty of 10% is imposed when money is withdrawn from an annuity contract before the age of 59.5 years.
  • An SPDA is accompanied by the added advantage of deferred tax. So, the income augments without having to pay any taxes. This tax waiver, however, is subject to keeping the money with the annuity firm for a specific period of time in which no withdrawal is made. Therefore, an early withdrawal tax (10%) in addition to income taxes on the total annuity gains is imposed.
  • Multiple fees are charged in return for the investment guarantees. It is, therefore, advised to thoroughly read and comprehend all the associated terms and conditions before opting for an SPDA.
  • The structure of deferred annuities is a bit complex, particularly when it comes to fixed and variable index annuities. An exclusive understanding of the investment terms, fees involved, and guarantees should be sought in consultation with some trusted financial guide.

Taxes and Withdrawals

The deferred annuity works very similar to IRAs and 401(k)s. The taxes are waived for annuitants who subscribe to the deferred annuity as long as they don’t start withdrawing the money from their annuity plan. Unlike the conventional brokerage account, the income escalates exponentially and additional savings are achieved from the waived taxes from the deferred annuities. These advantages can only be enjoyed before the annuitization period. On the other hand, in case of a premature withdrawal or contract termination before the age of 59 and a half years, a huge penalty is imposed in addition to income taxes on the financial gains of the annuity. The surrender charges are also imposed by the annuity company. The deferred annuities are, therefore, good for long-term investments only. 

How should you choose the deferred annuity?  

With this background, it is advised that a detailed understanding of the annuity and associated pros and cons must be known. The advice must be sought from a suitable financial consultant before opting for a deferred annuity. A quick takeaway, opt for a single premium immediate annuity plan (SPIA) if you suspect you may need the money in less than one year after starting a deferred annuity plan. The only requirement which delineates the selection of a single premium deferred annuity (SPDA) is a large amount in savings. This saving should be other than monthly income to meet day-to-day and health emergency-related expenses. As a whole, the Single-Premium Deferred Annuity (SPDA) is a very useful plan for long-term investment and a source of income after retirement.

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