In my previous post about Single Premium Deferred Annuities (SPDAs), I summarized Becky’s challenge to find a financial product for her retirement money that was safe from the volatility of the market1, but with greater interest earning potential than banking and other fixed interest products. Her situation was ideal for a fixed indexed SPDA.

SPDAs serve a lot of needs and don’t get enough credit for it. One reason for the slight is that they just don’t cut through the noise of so many types of financial solutions and options. Faced with too much choice of anything, we all tend to tune out most of it, often at the risk of missing some very good ideas. 

Such analysis paralysis in the investment world is probably behind another alarming trend: 66% of Americans can’t answer three of five very basic questions correctly on general financial topics (i.e., economics, inflation, compound interest, etc.), according to FINRA’s 2019 National Financial Capability Study.

So, the more you know about them, and their place in real-world situations, the more SPDAs can stand out in the crowded field. It then becomes clear why we consider them retirement planning’s “unsung hero.”

HERE ARE FOUR COMMON SCENARIOS WHERE FIXED INDEXED SPDAS CAN COME TO THE RESCUE:

1. AS A NON-QUALIFIED RETIREMENT SUPPLEMENT

Some savers “max out” on their qualified plans, such as 401(k)s, and then think they need to rely just on banks to park any additional savings. A better option may be an SPDA as a non-qualified alternative, which offers more interest crediting potential vs. most current interest-bearing accounts. Plus, when you start to take income, you’re only taxed on the interest earned, and not on your initial payment amount (it was already taxed once).

2. FOR GUARANTEED AND STEADY INCOME

Some choose to create an income portfolio in their brokerage account. This has the potential for capital growth in addition to income, but also the potential for loss of principal.2 If the account isn’t in an IRA, any income will be taxable each year. Plus, at retirement, you are responsible for managing the income stream which may require liquidating securities. On the other hand, an SPDA is designed for accumulation potential with choices based in part on the performance of market indexes but with 0% floor guarantees to protect your down side.3 Later, they offer the choice to take retirement income that stays constant and is guaranteed for the rest of your life.

3. AN ADDITIONAL PLAN FOR RETIREMENT INCOME

Many seek to turn to the cash value in a permanent life insurance policy to supplement retirement income using policy loans and withdrawals.4 But if you don’t already own permanent life insurance, it comes with insurability requirements which not everyone can meet as they age. Enter SPDAs, most of which include guaranteed lifetime income features. Plus, there are no medical questionnaires or other obstacles to clear. That said, you’ll never be rejected by an insurance carrier when purchasing an SPDA.

4. TAX-FREE RETIREMENT INCOME

Another lesser-known but powerful solution is to fund your SPDA within a Roth IRA. Remember, qualified distributions from Roth IRAs are tax-free, which means your guaranteed income from the annuity would also be tax-free and for the rest of your life.5

SPDAs are among the most versatile “go-to” vehicles for retirement planning, but despite their strengths they are often overlooked and misunderstood. Yet, they’re worth a look if you’re serious about turning a lump-sum into an income generating super hero. As always, talk with your financial professional about your options before considering any financial strategy or product.

  1. The 0% “floor” provided by an indexed annuity ensures that during crediting periods where the index is negative, that no less than 0% interest is credited to the index strategy. This means that premiums paid and interest earned won’t be reduced by market volatility.  This also assumes no withdrawals are made during the withdrawal charge period.  Rider charges continue to be deducted regardless of whether interest is credited.
  2. Investing involves risk, including the potential for loss of principal. Past performance does not guarantee future performance.
  3. Indexed annuities have withdrawal charges that are assessed during the early years of the contract if the annuity is surrendered. In addition, withdrawals prior to age 59 ½ may be subject to a 10% Federal Tax Penalty. Indexed annuities do not directly participate in any stock or equity investments.  Guarantees are dependent on the claims paying ability of the issuing company.
  4. Policy loans and withdrawals reduce the policy’s cash value and death benefit and may result in a taxable event. Surrender charges may reduce the policy’s cash value in early years.
  5. Buying an annuity within an Individual Retirement Account (IRA) doesn’t offer extra tax benefits beyond those offered by the IRA. If considering an annuity within an IRA, base your purchase decision on the annuity’s other features and benefits, as well as its risks and costs, not its tax benefits. To qualify for the federal tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five years, and the distribution must take place after age 59½ or due to death, disability, or a qualified special purpose distribution, which is a qualified first-time home purchase (up to a $10,000 lifetime maximum).  Depending upon state law, Roth IRA distributions may be subject to state taxes.