In the annuity world, it's possible to leverage an annuity and a life insurance policy for maximum benefit. It is commonly referred to as “annuity arbitrage." Many investors have heard the word arbitrage used in the securities world to explain the simultaneous buying and selling of stocks or other investments. This is done to try to capitalize on different market prices of the same asset. Arbitrage can also mean leverage, and there are ways to leverage insurance and annuity products to maximize the benefits and contractual guarantees of each policy.
How Annuity Arbitrage Works
Annuity arbitrage involves the purchase of a Single Premium Immediate Annuity (SPIA) and a Life Insurance policy at the same time. The structure of the annuity can be single-life or joint with a spouse. It’s important to structure both the annuity and the life insurance policy for maximum benefits, so it’s important to fully understand each.
What Is a Single Premium Immediate Annuity (SPIA)?
The oldest form of an income annuity provides the highest contractual payout of any annuity type. SPIAs are a pure transfer of risk pension plans that can be structured for a guaranteed lifetime income stream, income for a specific period, or a combination of both.
By setting up the annuity with your spouse (aka joint annuitant), the guaranteed income covers both lives. The highest contractual payout would be structured as “Joint Life Only.” If you want to make sure that 100% of the initial principal will go to someone in your family when both husband and wife die, then the highest contractual structure would be “Life with Installment Refund” or “Life with Cash Refund.”
Single-Premium Immediate Annuities have no fees, and Cost of Living Adjustment (COLA) annual increases can be contractually guaranteed at the time of application. SPIA income can begin as soon as 30 days from the time the policy is issued, but you can also defer for up to a year as well.
Benefits of the Annuity Arbitrage Strategy
This strategy really works well because all of the benefits are contractually guaranteed. Even though "annuity arbitrage" is usually fully customized, below is a common setup and the corresponding benefits:
- A Single Premium Immediate Annuity (SPIA) is purchased in a joint life structure so that a lifetime income stream is guaranteed for both lives.
- A life insurance policy (preferably term life) is purchased for one of the spouses. The death benefit amount can be determined at the time of application, along with the monthly or annual premium needed.
- The SPIA premium amount needed is calculated so that the income stream from the annuity covers the life insurance premium for as long as the insured spouse lives.
- Upon the death of the insured spouse, the death benefit from the life insurance policy passes tax-free to the listed beneficiary.
- The SPIA lifetime income guarantee continues uninterrupted to the surviving spouse, and they receive the tax-free death benefit from the life insurance policy as well if they are the listed beneficiary of the policy.
There are many other annuity strategies that use leverage to maximize contractual benefits. However, the annuity arbitrage strategy just described is the most popular and most common.
The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risk, including the possible loss of principal.