What Is a Single Premium Deferred Annuity?

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DEFINITION

A single premium deferred annuity (SPDA) is a financial product that guarantees a steady stream of payments over a period of time, regardless of the market's performance.

Definition and Example of a Single Premium Deferred Annuity

A single premium deferred annuity is a financial tool that can provide a regular income. Like other kinds of annuities, you must make an initial investment. In this case, the annuity is established with just one payment. This lump sum is a premium that is paid upfront. Depending on the annuity, some will have a minimum investment of around $5,000, while others run well into the millions.

  • Abbreviation: SPDA

Single premium deferred annuities are popular with conservative investors who want insurance that they will have an income in retirement, regardless of what the broader market might do. They are easiest to set up when you have a single large sum of money to invest. You might start an SPDA after you:

  • Receive an inheritance
  • Collect a 401(k) with a large balance after an employment separation
  • Sell a business

How a Single Premium Deferred Annuity Works

A deferred annuity is one that doesn’t start paying right away. You first fund the account and then later, at a time of your choosing, start to receive payments.

Because annuities are often tax-deferred, they come with the same rules as other retirement accounts that receive this favorable tax treatment. You will have to wait until you are at least 59 1/2 before withdrawing funds, or you will pay a 10% penalty on top of the ordinary income taxes that come with the withdrawal.

Deferred annuities also come with guarantees. Generally, even if the market has a bad year, your account will not lose money.

With an SPDA, the least you can receive is nothing. There are no negative returns. The price for that guarantee is the loss of some upside. If the financial markets have an incredible year, your gains may be capped at a certain amount, and the insurance company would keep the rest, ensuring that there is still some money to be paid out in a bad year.

Annuities of this type have surrender penalties that encourage you to keep the money invested for a long period. If you have to withdraw funds within the first ten years, or whatever the insurer writes into the contract, you will pay a surrender fee.

Some insurers will allow a free withdrawal of a certain amount and/or lower the surrender fee each year until it goes away completely. At that point, you won't have to pay fees if you withdraw your funds.

Pros and Cons of Single Premium Deferred Annuities

Pros
  • Guaranteed income

  • Lowers market risk

  • Simplifies tax planning

Cons
  • Minimal wealth creation

  • Expensive fees

  • Large upfront investment

  • Illiquid

Pros Explained

  • Guaranteed income: An annuity provides regular payments during retirement, which gives you a stable, reliable source of income that can make retirement planning much easier.
  • Lowers market risk: You wouldn't have to worry about the financial markets crashing not long before you retire or other unforeseen risks that could wipe out gains in your other retirement investments.
  • Simplifies tax planning: Because your income would be reliable and regular, you could plan your tax strategy for retirement ahead of time, including how you would use your other investments and retirement funds.

Cons Explained

  • Minimal wealth creation: An annuity is similar to an insurance product. You pay a monthly premium to protect against the risk of loss, but it doesn't build wealth. Instead, your wealth creation will have to come from investment products.
  • Expensive fees: Annuities have high fees, compared to some other investment products.
  • Large upfront investment: A single premium deferred annuity is only accessible if you have a large amount of money to pay the initial premium. Depending on the size of the premium and how long you live, the payments you receive might never equal the premium you paid.
  • Illiquid: Because of the early withdrawal penalties and surrender fees, an SPDA is not a liquid account. You cannot access your money easily if you suddenly find that you need cash.

Alternatives to a Single Premium Deferred Annuity

If an SPDA isn't the right choice for you, there are other annuities that you can invest in. They’re often used to guarantee a monthly stream of income regardless of market conditions. Think of an annuity like a pension.

Most annuities will come with monthly payments rather than a single lump-sum premium. Just like some IRAs or 401(k)s, the proceeds grow tax-free until you begin taking distributions of the funds. As you pay into this type of annuity, the insurance company will invest the funds. Depending on the contract, you may have a say in how those funds are invested.

Another alternative for investors with a large sum is an IRA with an appropriate risk profile.

Key Takeaways

  • Single premium deferred annuities (SPDA) are set up with one large payment and provide a guaranteed income thereafter.
  • SPDAs often have high fee structures and a large initial premium that can make them inaccessible for some investors.
  • SPDAs are strong options for conservative investors and can help them plan for future tax consequences.

Article Sources

  1. Internal Revenue Service. "Publication 575 (2020), Pension and Annuity Income."

  2. U.S. Securities and Exchange Commission. "Variable Annuities: What You Should Know," Page 13.