Older Americans heading toward retirement can face a conundrum: They'll need income when they leave work, yet they want to delay taking Social Security for as long as possible so they can maximize those benefits.
For clients who have other assets available, some advisors recommend that instead of gradually withdrawing from those accounts — i.e., a 401(k), individual retirement account, brokerage, savings — they instead move some of the money to a single-premium immediate annuity to bridge that gap in income.
"It's certainly a valid option," said certified financial planner Ronald Myers, a managing member at Fortune 360 Group in Plantation, Florida. "But is it a good option? That's a different question."
Annuities, which offer varying levels of guaranteed income either for a set time period or for life, come in a variety of packages and can often be tricky to understand and, depending on the type, more expensive than other options.
Yet SPIAs, as they're called, generally are more straightforward than their brethren. They make up a fraction of annuities sold yearly — just $9.7 billion of $233.7 billion in 2018, according to the LIMRA Secure Retirement Institute.
In retirees' quest to ensure their savings stretch through their lifetime, the option can end up being a viable piece of the retirement planning puzzle. However, SPIAs also have limitations. And some advisors say there are better ways to fund a short-term income gap.
"A SPIA is a place to secure a payout for a period of time," Myers said. "It's not a place to make money."
Basically, in exchange for guaranteed income over a set period of time (or for your lifetime), you give an insurance company a lump sum, which in turn becomes part of the insurer's pooled investments. There is no setup fee for a SPIA contract, and unlike some annuities, it comes with no annual expenses.
However, once you hand over the cash and the short window to change your mind ends, you generally can't get your money back — except in the form of payments that you already agreed to.
"All you're left with is an income stream," said David Mendels, a CFP and director of planning at Creative Financial Concepts in New York. "So if you have a medical emergency or something like that, you don't have that money available."
Some insurance companies do offer SPIAs that allow for a limited emergency withdrawal or a similar arrangement, although contracts with any extras generally will not pay as much each month.
You also can get one that allows for a joint owner. Or if you name a beneficiary, the payments would shift to that person if you were to die before the end of the contract.
Additionally, it's important to know the annuity's income will be taxed. If you use money from a tax-deferred account — say, an IRA or 401(k) — to fund the SPIA, you'll pay taxes on it as you receive it over the length of the annuity contract.
If the funding source was from accounts that are not tax-advantaged, such as a brokerage or savings account, you'll only pay taxes on the portion of SPIA income that wasn't already taxed through what the insurance company calls an exclusion. (Keep in mind, though, that liquidating funds from a brokerage account comes with its own tax implications.)
Your money also won't be earning much. For example, earlier this year, Ronald Palastro, a CFP with Cobblestone Wealth Advisors in Brooklyn, New York, had a client who wanted guaranteed monthly income of $2,750 for five years. This was so he could delay taking Social Security until age 70, at which point his benefits would reach their maximum.
To get the monthly income needed, the insurance company required $156,500 upfront. While the math gets a bit tricky, the rate of return cited by the insurer was just over 2.1%.
"It's not a great rate, but for the purposes of giving him guaranteed income, it made sense in this situation," said Palastro.
Some advisors say that instead of using SPIAs, people looking for income that isn't subject to the whims of the stock market could consider certificates of deposit.
While the interest earned also isn't high — you can find one-year CDs offering up to about 2.15% currently — the option can provide you with more liquidity than SPIAs, along with a guaranteed rate of return. It also generates more interest than a regular savings account.
Similarly, U.S. Treasury bonds, which are backed by the government, can also provide a type of guaranteed income. The one-year Treasury yield is currently about 1.5%. The five- and 10-year yields are slightly higher but below 2%.
Regardless of other options, advisors say SPIAs are largely about peace of mind for some clients. And SPIAs often can help protect assets, depending on the individual's spending habits.
"A lot of people aren't good at managing their money, so if left with the option of withdrawing more than they should, they will," Myers said. "A SPIA won't let you. It can protect people from themselves."