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.
Let’s See How It 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, with the life insurance policy being typically taken out on the husband. 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 SPIA or Single Premium Immediate Annuity?
The oldest form of an income annuity is still the best and 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.
I recommend setting up the annuity with your spouse (aka joint annuitant) so that 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 COLA (Cost of Living Adjustment) 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.
The Life Insurance That Works With the "Annuity Arbitrage" Strategy
I always tell people that life insurance will provide the best return on investment you will never see. Get it? You’re dead, but your beneficiaries will love you for taking out that life insurance policy.
The only possible hurdle with life insurance is to qualify for it. In order to buy life insurance, you have to go through an underwriting process that involves a physical, blood tests, and a thorough review of your medical records. This process can take a while, and patience is a virtue during the underwriting of your policy. I don’t sell life insurance (i.e. Stan The Annuity Man), but I have a theory that you should buy as much death benefit possible with as little money as possible. That pretty much defines term life insurance. My advice is to buy what is called “level term” which guarantees the premium won’t change. I recommend locking in those premium rates for as long as possible, like to age 90 or longer.
If there is no life insurance, then there is no annuity arbitrage. It's essential that one of the spouses qualifies for life insurance.
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 set up 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 on one of the spouses, typically the husband. 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 (typically the wife).
- 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. Maybe it’s something that could work for your specific situation.