What Is a Single Premium Immediate Annuity (SPIA)?

A Single Premium Immediate Annuity (SPIA) represents a contract established between an individual and an insurance company. This financial product is characterized by a one-time, lump-sum payment, known as the “single premium,” made by the individual to the insurer. In exchange for this payment, the insurance company commits to providing a guaranteed stream of income payments. The “immediate” aspect signifies that these payments begin very soon after the premium is paid, typically within one year, often within one month of purchase.

This income can be structured to last for a specified period or for the remainder of the annuitant’s life. This arrangement effectively transfers the risk of outliving one’s savings from the individual to the insurance company.

Individuals often use funds from retirement savings, inheritances, or other large financial windfalls to purchase an SPIA. Once the single premium is paid, the contract is generally considered irrevocable, meaning the funds are committed and typically cannot be withdrawn as a lump sum or altered without significant penalties.

How SPIAs Provide Income Payments

The mechanics of how an SPIA generates and distributes income involve the insurance company assuming responsibility for future payments after receiving the lump-sum premium. The payments are typically fixed amounts, providing a predictable and stable source of income.

The process of converting a lump sum into a series of periodic payments is known as annuitization. Once annuitized, the insurance company uses actuarial science to calculate the payment amounts, taking into account several factors. These factors include the annuitant’s age and gender, which are used to estimate life expectancy.

Additionally, the amount of the initial premium payment and the prevailing interest rates at the time of purchase significantly influence the payment size. Higher interest rates generally result in larger income payments. While payments are often monthly, individuals can typically choose other frequencies, such as quarterly, semi-annual, or annual payments, though this timing usually cannot be changed once established.

Key Features and Payout Options

Once purchased, an SPIA contract is generally irrevocable, meaning the initial lump sum cannot be easily accessed or the payment terms significantly altered. This characteristic provides the assurance of a steady income stream but also means a lack of liquidity for the invested funds.

SPIAs offer several common payout options that determine how income is received and for how long. A “Life Only” option provides payments for the entire life of the annuitant, ceasing upon their death. With this option, there is typically no death benefit, and payments stop even if death occurs shortly after payments begin.

The “Period Certain” option guarantees payments for a specific number of years, such as 10 or 20, even if the annuitant dies before the period ends. If the annuitant passes away during this guaranteed period, the remaining payments are made to a designated beneficiary. A “Life with Period Certain” option combines these, providing payments for life but guaranteeing them for a minimum number of years. If the annuitant outlives the period certain, payments continue for their lifetime; otherwise, beneficiaries receive payments for the remainder of the guaranteed period.

A “Joint and Survivor” option extends payments for the lives of two individuals, typically a spouse or partner. Payments continue as long as either annuitant is alive, often with a reduced payment amount to the survivor after the first annuitant’s death. Some SPIAs also offer an “Inflation Protection” or Cost of Living Adjustment (COLA) rider, which increases payments over time to help combat inflation, although this usually results in lower initial payments.

Taxation of SPIA Income

The taxation of income received from a Single Premium Immediate Annuity depends on whether the annuity was purchased with pre-tax or after-tax money. Annuities funded with pre-tax dollars are known as “qualified” annuities, typically bought within retirement accounts like a traditional IRA or 401(k). Withdrawals from qualified SPIAs are generally taxed as ordinary income because the original contributions were not taxed.

Conversely, “non-qualified” SPIAs are purchased with after-tax money, meaning the principal contributions have already been taxed. For these annuities, only the earnings portion of each payment is subject to income tax. The Internal Revenue Service (IRS) employs an “exclusion ratio” to determine the non-taxable portion of each payment, which represents a return of the principal, and the taxable portion, which is considered earnings.

The exclusion ratio is calculated by dividing the investment in the contract (the premium paid) by the expected total return over the annuitant’s life expectancy, as determined by IRS tables. Once the annuitant has received payments totaling their original investment (cost basis), any subsequent payments become fully taxable as ordinary income. All distributions from an annuity, whether taxable or not, are typically reported to the IRS on Form 1099-R.