Retirement Planning

Single Premium Immediate Annuities (SPIAs) And IRAs

A single premium immediate annuity is an annuity contract with an insurance company in which the contract owner contributes one lump sum (single premium) and immediately begins to receive annuity distributions either monthly, quarterly, semi-annually or annually from the insurance company. Oftentimes the agreement with the insurance company is to receive a specified amount for life pursuant to the account holders life expectancy. Commonly referred to as a SPIA, this annuity has no accumulation period, or period of time in which the annuity grows in value due to appreciation of the underlying assets and/or due to future contributions (future premium payments).

Most SPIA distributions are regular, level payments. Your primary distribution options include:
1. Single Life - The SPIA distribution payments cease upon the death of the account holder.
2. Joint and Survivors Annuity - The SPIA distribution payments (lower in amount than single life payments) continues to pay annuity distributions to a surviving beneficiary.
3. Period Certain - The SPIA distribution payments cease after a specified period of time, even after the account holders death, in which case the designated beneficiary receives the remaining distributions.

The main purpose of a SPIA is to provide retirement benefits for the account holder and/or spouse. SPIA's are funded either with after-tax contributions (known as non-qualified SPIA) or with pre-tax contributions (known as qualified SPIA). After-tax SPIAs distributions are part tax-free (a portion of the distribution is considered a return of contribution and, thus, not taxable). Pre-tax contributions are funded by employee retirement plan assets which are, themselves, funded with pre-tax contributions such as 401(k) plan employee contributions and employer matching contributions. In this case the SPIA is created when the retirement assets are converted to a SPIA, upon retirement. This pre-tax, or qualified SPIA most often involves the utilization of an Individual Retirement Arrangement (IRA).

Pre-Tax SPIAs and IRAs
There are only two types of IRAs:
1. Individual Retirement Account and
2. Individual Retirement Annuity

A Pre-Tax SPIA may be purchased by rolling retirement funds into an Individual Retirement Account and then purchasing a SPIA, inside an Individual Retirement Account. In such case, the IRA is the owner and recipient of the SPIA distributions and Required Minimum Distribution (RMD) rules apply to the Individual Retirement Account, which includes the value of the SPIA.

A Pre-Tax SPIA may be purchased by rolling retirement funds directly into an Individual Retirement Annuity, which then purchases the SPIA. In such case the SPIA distributions are considered paid directly to the individual owner of the SPIA. With an Individual Retirement Annuity there is no IRA Account RMD requirement (the SPIA calculates its own separate minimum distribution amount) as the IRS assumes the IRA Annuity will pay out distributions that equal or exceed any RMD calculation.

In some cases an individual will roll over retirement funds into an IRA Account and then use some of those funds to purchase a SPIA. There is much confusion regarding the RMD rules in this case so let's clear it up. When you use part of your IRA Account to purchase a SPIA, the SPIA is part of the IRA Account and you must calculate your RMD by including the value of the SPIA. This can be tricky as the value of the SPIA may not be easily determinable every year. Because an RMD is based on the value of the funds in the IRA Account at the end of the prior year (i.e. a 2011 RMD is based on the value of your IRA Account as of 12/31/10) you must include in this value calculation the value of the SPIA. How is this done? You must determine the present value of the SPIA at the end of the prior year so that the value of the Individual Retirement Account can be determined in order to then determine the RMD.

Because of this added complexity in buying a SPIA inside an Individual Retirement Account, knowledgeable financial advisors will advise purchasing a SPIA through the use of an Individual Retirement Annuity and avoid the purchase within an Individual Retirement Account.

Tom is a Certified Public Accountant, a Certified Financial Planner, CLTC (Certified Long-Term Care) and President of Cerefice & Company, the largest CPA firm in Rahway, New Jersey. Tom works with clients helping them manage their money, retirement planning, college savings, life insurance needs, IRAs and qualified plan rollovers with an eye towards maximizing tax benefits and minimizing taxes. Tom is founder of the Rich Habits Institute and author of "Rich Habits".