(Herald-Tribune) - Interest rates are rising along with inflation. The former is good for investors, the latter not so much. However, there is a way that risk-averse investors requiring assured income and perhaps inflation protection can deal with both. They can use part of their capital to buy a Single Payment Immediate Annuity (SPIA).
Why not just stocks and bonds?
While stocks are likely to provide long-term growth, their volatility means that relying solely on capital gains to pay bills can be unsettling for risk-averse investors. While dividends are reliable, they could be cut at any time. High-quality intermediate-term bonds, while having safe interest payments, can drop in value when interest rates rise, and their payments are around 4.5%. More important, since the payments are fixed, even if they were able to meet today’s needs, due to inflation, they are unlikely to meet tomorrow's.
One possible component of a solution to this conundrum, at least for risk-averse retirees, is the SPIA. This is a contract between the buyer and an insurance company. The buyer gives the insurance company a lump-sum premium, and the company commits to immediately begin providing periodic fixed-dollar payments for a set period, commonly monthly over the client’s lifetime. Doing this transfers the risk of running out of money from the retiree to the company.
Here, we only consider SPIAs that pay over a client’s lifetime and stop upon death. Many insurance companies offer added options. Two examples: pay until both the buyer and spouse die; increase payments with inflation.
SPIAs bought with after-tax dollars can offer significant tax advantages, especially for high-income retirees. This is because a significant part of the monthly income is considered a return of principal and is not taxed. This benefit ends when the buyer receives back her entire initial premium. However, the 3.8% Medicare tax could apply to the taxable part of monthly checks.
One benefit of SPIAs is that research shows that retirees using them as part of a diversified long-term retirement income strategy, including stocks, have a much smaller chance of falling into poverty and may be able to spend more each year. This is due to the possibility of investing the reminder of the nest egg more aggressively. Purchasing an annuity that, when added to pensions and Social Security, covers the retiree’s normal living expenses is a reasonable strategy as it can reduce stress.
Since income from a SPIA will be higher the older the buyer is when it’s purchased, putting off the purchase until 70 or later, when possible, makes sense.
Inflation can be an issue for younger retirees who don’t include stocks in their portfolios. Unless an inflation-indexed annuity is selected, the annuity’s payments are fixed for life and inflation will reduce the retiree’s purchasing power.
As an example of possible income: Recently, at immediateannuities.com, a 70-year-old male could get an estimated (non-inflation protected) monthly income of $710 for a $100,000 initial payment. A female could get $680. Both provide cash flow of over 8%. Adding inflation protection would lower these amounts.
Robert Stepleman - Special to the Herald-Tribune
March 27, 2023
All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.
