This is a common question among people seeking to receive immediate income from an annuity. The simple answer is… there really is not a simple answer!
Single Premium Immediate Annuity (SPIA) is a product where you as the annuitant give the insurance company a lump sum of cash. In return, the insurance company promises you a payment that you cannot outlive. For many, the comfort of knowing that if you live to be 115 years old, you’ll still receive a check from the insurance company. The calculation is based on the amount of premium you give the insurance company, your age, and what period of time you want to receive payments.
You also have an alternative method too. Instead of receiving a payment for lifetime, you can select to have payments come to you for a certain period of time. In the industry, we call this “period certain.” As the annuitant, you can usually select any period of time less than 25 years. There are many variations and combinations of payment periods you can create and select.
A common question from potential buyers of a SPIA is, “what is my interest rate going to be?” The answer is, any payment you receive once your initial payment has been recouped must be considered “interest.”
For our hypothetical example, let’s use a 62-year-old male, with $250,000 to deposit into a SPIA. Let us also assume the lifetime payment will be $20,000 per year. At $20,000/year, in 12.5 years, the $250,000 he allocated toward the annuity will be repaid. Consequently, every payment he receives after 12.5 years is his “interest.” If he lives 23 years (age 85), then his total payment will be $460,000 and that means his net interest will be $210,000 or 84%! The longer he lives (and receives his $20,000 payment) the higher his “interest” is going to be!