Annuities began as the simple concept of cash in exchange for income. Before bonds were created, governments used annuities as a way to raise capital while simultaneously providing steady annual income for its citizens.

Because the possibility of outliving retirement income is a real threat, investors have increasingly turned to annuities as a refuge from economic uncertainty. One such annuity that can offer a secure stream of income to continue throughout your retirement years is the single premium immediate annuity - or SPIA - which has been around nearly as long as governments have existed.

Today, annuities are issued by life insurance companies but remain fundamentally unchanged in purpose. With the prospect of funding an average of 20 to 30 years of retirement, retirees are smartly seeking dependable and time-tested income vehicles that will see them through the rest of their retired years.

With a SPIA, you, the annuitant, enter into a contract with an insurance company whereby you give them a lump-sum of money in exchange for a guaranteed stream of income payments. You determine whether this guaranteed stream of income will be for life, for a specified period of years, or for some combination thereof. Your annuity payment - the payout rate - is based on the initial investment amount, the number of payment periods, and an assumed rate of interest.

The payout rate includes an exclusion ratio that calculates how much of your payment is comprised of principal and is, therefore, excluded from any tax liability. If your exclusion ratio is calculated to be 75%, for example, a monthly payout of $1,000 would be broken down into $750 of principal, excluded from tax, and $250 that would be subject to ordinary income tax. It is important to note that if a lifetime payment option is chosen, the insurance company is contractually obligated to continue payments even when you outlive your actuarially calculated life span and have exhausted the annuity principal. Consequently, your entire payment after the exhaustion of principal is taxable.

There are many ways to structure your SPIA payments. The simplest form is the single life payment plan, which distributes cash while you are living and ceases upon death, regardless of principal balance. You can also customize your payout option to include payments to a spouse after your death. There are many features that may be added to SPIAs, but note that additional features often equate to smaller payout rates. Deciding how to structure your SPIA is an important retirement step, and one that your Financial Advisor can assist you in determining.

While the SPIA owes much of its existence to a financial instrument from many years ago, modern day investors seeking security and peace of mind may find it as timely as ever.

To learn more, contact a Financial Advisor today.