Single premium immediate annuities (SPIAs) and deferred income annuities (DIAs) are often used to provide sustainable lifetime income to replace a portion of employment income in retirement. Both are tax-favored when nonretirement funds are used to purchase them since a portion of each income payment is a nontaxable return of principal.
The primary difference between a SPIA and a DIA is the annuity commencement, or income start, date. In the case of SPIAs, it is one month after purchase assuming a monthly payment frequency. With DIAs the income start date is a contractually defined date at least 12 months from the date of purchase. The longer the deferral period, the greater the periodic payment will be.
SPIA and DIA Income Payment Parameters
The periodic income payment amount for both SPIAs and DIAs is dependent upon several parameters, most of which are elective. These include:
- Annuity type: single or joint life
- Joint type in the case of joint life: reducing or non-reducing
- Birth date(s)
- Purchase date(s) (dates in the case of DIAs that allow multiple purchases)
- Premium amount(s) (amounts in the case of DIAs that allow multiple purchases)
- Income start date
- Payment frequency, i.e., monthly, quarterly, etc.
- Return of premium option in the case of DIAs
- Income payment option
The last parameter, income payment option, can make a huge difference in the total amount of payments in the event of premature death. I’m using “premature death” to refer to death occurring prior to the annuitant receiving at least ten years of income payments.
Lifetime Income Payment Options
While DIAs can be purchased for a fixed term, e.g., five or ten years, DIAs and SPIAs are usually purchased for lifetime income. There are four lifetime income payment options to choose from when purchasing DIAs and SPIAs, all beginning on the annuity commencement date, with the following differences in the event of death:
- Life only: Payments end.
- Life with cash refund: Difference between the sum of lifetime income payments and premium payments is paid to the beneficiary(ies) in one lump sum.
- Life with installment refund: Difference between the sum of the lifetime income payments and the premium payments will continue to be paid to the beneficiary(ies) until the sum of the income payments equals the premium payments.
- Life with period certain: Income payments will be paid to the annuitant(s) and/or beneficiaries for a fixed number of years, usually 10 to 30, in the event that death occurs prior to the period certain.
The life only income payment option generally provides the largest periodic payment amount due to the fact that payments end upon death. Although this is the least risky option for an insurance company, it is the most risky for an annuitant.
As an example, suppose that you’re single and you purchase a SPIA that pays lifetime monthly income of $1,000 beginning one month from today. After receiving three months of payments, or a total of $3,000, you have a heart attack and die. The insurance company has fulfilled its obligations to you and there will be no additional payments.
Life Only vs. Life with Period Certain
Whether you’re considering a SPIA or a DIA, a life with period certain payment option is often the best choice. As previously stated, the number of years you can choose generally ranges from 10 to 30. The longer the period certain, the smaller will be the periodic payment amount.
While there will be a sizable reduction in the periodic payment amount with both the life with cash refund and life with installment payment options due to the guarantee that at least 100% of premium payments will be returned, it will generally be insignificant for a 10-year certain vs. life only payout. This is true whether you’re looking at a SPIA or a DIA.
To illustrate this, I prepared quotes for all of the SPIAs and DIAs available through my life insurance agency for a non-reducing joint life contract for a husband and wife issued in California on July 19, 2016 with a premium of $200,000 with the following additional parameters:
- SPIA: primary annuitant (male) birth date of April 20, 1946 (age 70), secondary annuitant (female) birth date of June 10, 1949 (age 67), and income start date of August 19, 2016 (one month from purchase date).
- DIA: primary annuitant (male) birth date of April 20, 1961 (age 55), secondary annuitant (female) birth date of June 10, 1964 (age 52), and income start date of July 19, 2031 (15 years from purchase date).
The average monthly payment for 11 SPIAs with a life only payment option was $889.53, or $1.51 greater than the average monthly payment of $888.02 for the same 11 SPIAs with a 10-year certain payment option. Using the average monthly payment, ten years of payments totaling $106,562.40 ($888.02 x 12 months x 10 years) can be guaranteed by choosing a 10-year certain payout vs. potential payments of $0 if you instead choose the life only option and you die before the first payment is distributed.
When you purchase a DIA, in addition to the income start date, there’s one other important choice you need to make – purchase with or without a return of premium. Although I ran the DIA quotes with and without this additional parameter, the difference in monthly payment amounts was also insignificant.
Given the fact that (a) the income payment begins on the annuity commencement date and, (b) by definition, there will be a period of at least one year, and usually much more, between the purchase date and the income payment date whenever you purchase a DIA, your beneficiaries will receive nothing from the insurance company in the event that you, and another individual in the case of joint annuitants, die before the annuity commencement date unless you include a return of premium feature. Assuming this is part of your contract, your beneficiary(ies) will receive 100% of your premium payments in the event that you, and another individual in the case of joint annuitants, die before the annuity commencement date.
Whether or not a return of premium feature is included in your contract, the difference in monthly payment amount for a DIA is generally insignificant. I ran five DIA quotes with no return of premium and three with this option. The average monthly life only payment for the five without a return of premium was $1,416.98, or $13.76 greater than the average monthly payment of $1,403.22 for the same five with a 10-year certain payment option. The average monthly life only payment for the three that include a return of premium was $1,434.37, or $10.24 greater than the average monthly payment of $1,424.13 for the same three with a 10-year certain payment option.
Using the average monthly payment, ten years of payments totaling $168,386.40 ($1,403.22 x 12 months x 10 years) is guaranteed with no return of premium, and $170,895.60 ($1,424.13 x 12 months x 10 years) with a return of premium by choosing a 10-year certain payout vs. $0 if the life only option is chosen instead. In addition, the annuitants’ beneficiary(ies) would receive a return of the premium of $200,000 in the event both spouses die before the annuity commencement date of July 19, 2031 if a return of premium feature is included.
There are four takeaways from this post:
- Never choose a life only income payment option when purchasing SPIAs or DIAs unless you have no potential individual or charitable beneficiaries.
- There will be an insignificant reduction in the periodic payment amount with a 10-year certain vs. a life only payment option.
- While you, your spouse, and/or your beneficiaries may not receive income payments equal to 100% of your premiums in the event of premature death, the total payments will be much greater with a 10-year certain vs. life only payment option.
- Always include a return of premium feature when purchasing DIAs unless you have no potential individual or charitable beneficiaries .
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.