Individual’s approaching retirement generally have one thing that keeps them up at night. They wonder, “Does my 401k or IRA have enough value to retire” or “What happens if I happen to outlive my retirement by living too long”. These are both very valid concerns for an investor to have running through their head.

However, there are many different strategies that can help to appease this particular concern. One such product that prevents this from happening is the immediate annuity or single premium annuity.

A Lesson in Immediate Annuities

Single Premium Immediate Annuities (SPIAs) are purchased with a single deposit amount. As the name implies, the annuity usually start making regular monthly payments to you immediately after you turn over the funds to the insurance company. Typically this means 30 days from the date of deposit; but within certain limits you can also to defer the date that payments begin.

The first thing you need to understand is what actually happens when you buy an immediate annuity. In return for a sum of money, the insurance company promises to make regular payments to the owner or annuitant (if different) for a specific period, such as the remainder of the annuitant’s life. The payments can be set up in any of a variety of different ways (see below); however, whatever form you do select at the time of purchase cannot be changed at a later date. In accepting this guaranteed schedule of payments you also give up the right to demand the return of your original deposit, for example in the form of a lump sum less any payments that have already been received. In short, once the payments of an immediate annuity have begun, the contract generally cannot be revised or cashed in.

Why should I consider buying an Immediate Annuity? What are its advantages to me?

These are a many advantages that immediate annuities can provide to the buyer. Here is a list of just a few:

1. Security- the annuity provides stable lifetime income which can never be outlived or which may be guaranteed for a specified period;
2. Simplicity- the annuitant does not have to manage his investments, watch markets, report interest or dividends;
3. High Returns- the interest rates used by insurance companies to calculate immediate annuity income are generally higher than CD or Treasury rates, and since part of the principal is returned with each payment, greater amounts are received than would be provided by interest alone;
4. Preferred Tax Treatment- it lets you postpone paying taxes on some of the earnings you’ve accrued in a “tax-deferred” annuity when rolled into an immediate annuity (only the portion attributable to interest is taxable income, the bulk of the payments are nontaxable return of principal);
5. Safety of Principal- funds are guaranteed by assets of insurer and not subject to the fluctuations of financial markets; and
6. No sales or administrative charges.

Forms of Immediate Annuities:

The most basic life annuity is known by several names, including “Single Life,” “Straight Life,” “Life Only,” or “Non-refund” annuity. In its simplest form, it provides guaranteed payments over the lifetime of one person, with payments ceasing upon the annuitant’s death. By offering a way of insuring that you will not outlive your financial resources, a Single Life annuity can be an important tool in planning for retirement. A Single Life annuity also provides the highest payout of any lifetime annuity, because it carries the smallest risk for the insurer.

One of the key factors in pricing a life annuity is the average life expectancy of the person that will be receiving the payments. In a sense, purchasing a life annuity is like making a bet with an insurance company about how long you will live. Since the insurer will stop making payments when you die, it is betting that you won’t live beyond your life expectancy. On the other hand, you come out the winner if you do live longer than the average person, because the insurance company will have to continue making payments beyond the period it had assumed.

The coverage of a life annuity can be increased by including a second person (”Joint and Survivor” annuity), by adding a guaranteed period of time (”Period Certain” annuity), or by guaranteeing that payments will continue at least until the original purchase amount has been paid out (”Installment Refund” annuity). The added risk to the insurer is likely to reduce monthly payments by about 5% to 15%, depending on the age of the annuitants and the length of the guarantee period. Annuities with this kind of added coverage are particularly suitable: (1) when there is a need to guarantee income over the lifetimes of a husband and wife (”Joint and Survivor” annuity); (2) when payments must continue for a specified period (e.g. 5 or 10 years or more) to a designated beneficiary (”Certain and Continuous” annuity); or (3) when the annuitant wants to make sure that, if he should die before his initial investment has been fully distributed in monthly payments, an amount equal to the balance of the deposit continues to a named beneficiary (”Installment Refund” annuity).

Funds That Purchase an Immediate Annuity
Source of Funds – Qualified vs. Non-Qualified

Qualified Immediate Annuities

The term Qualified (when applied to Immediate Annuities) refers to the tax status of the source of funds used for purchasing the annuity. These are premium dollars which until now have “qualified” for IRS exemption from income taxes. The whole payment received each month from a qualified annuity is taxable as income (since income taxes have not yet been paid on these funds). Qualified annuities may either come from corporate-sponsored retirement plans (such as Defined Benefit or Defined Contribution Plans), Lump Sum distributions from such retirement plans, or from such individual retirement arrangements as IRAs, SEPs, and Section 403(b) tax-sheltered annuities, or Section 1035 annuity or life insurance exchanges.

Generally speaking, insurance companies use male/female (sex-distinct) rates to price qualified annuities in situations where the purchaser and/or owner is a corporation. When the annuity is being purchased by an individual, annuity rates are generally unisex. Some states, however, require that unisex rates be used for all qualified annuities.

Non-qualified Immediate Annuities

Non-qualified immediate annuities are purchased with monies which have not enjoyed any tax-sheltered status and for which taxes have already been paid. A part of each monthly payment is considered a return of previously taxed principal and therefore excluded from taxation. The amount excluded from taxes is calculated by an Exclusion Ratio, which appears on most annuity quotation sheets. Non-qualified annuities may be purchased by employers for situations such as deferred compensation or supplemental income programs, or by individuals investing their after-tax savings accounts or money market accounts, CD’s, proceeds from the sale of a house, business, mutual funds, other investments, or from an inheritance or proceeds from a life insurance settlement. While most insurance companies apply their male/female (sex-distinct) tables to non-qualified annuities, some states require the use of unisex rates for both males and females.

By Steve Martin, CMCT

Most people will happily agree to help a colleague out at work who has helped them out previously, take their turn to buy lunch when others have bought lunch before and remember to send a birthday card to the people who have sent them a card on their birthday.

The principle of reciprocity is a well accepted societal norm and has been extensively studied by social scientists. Its influence runs so deep that obligations can reach long and powerfully into the future (Cialdini 2001). But will people be just as likely to live up to the rule of reciprocity and return a favor in situations where nobody will ever know if the favor is returned?

Researchers Jerry Burger and his colleagues from the Department of Psychology at Santa Clara University tested this idea by setting up a study in which participants were asked to take part in a series of tasks to test “personality and perception skills”. In fact the “personality and perception” tests were a cover for the real study which involved certain participants being given a bottle of water by another study participant (the favor condition). The person who gave out this unexpected gift was actually a research assistant involved in the study. In a second condition the research assistant didn’t hand out bottles of water to anyone (the no-favor condition).

At the end of the test the researcher asked all the participants if they would be willing to complete a survey and return it a couple of days later. Half the people asked to complete the survey were led to believe that the person would be present when they returned the survey but the other half were told to leave the survey anonymously in a drop off box.

As you would expect, significantly more people who were given a bottle of water complied with the request to complete and return the survey compared with the group that were not given a bottle of water (30% v 5%). A good example of the reciprocity effect in action.

What is potentially more interesting is the fact that the people who believed their response would be anonymous were just as likely to live up to the rule of reciprocity and return the survey as those who believed that their act of repayment would be witnessed.

This means that even in situations where the giver of the original favor is unlikely to find out whether their favor has been reciprocated, they can be confident there is a good chance it will be.

This fact should be especially comforting for those working in certain business environments.

Leaders who employ large teams of people and manage them through groups of other managers, or managers who lead teams who work in different office locations (or even different countries) can be assured that even if they only rarely see their staff they should never fail to seek ways to employ the principle of reciprocity. Giving your time, trust, attention and providing useful information will be useful activities that teams will be likely to reciprocate even if you are not around to witness it.

Another situation where this study could provide useful insights is for those who do business online and as a result rarely, if ever, come face to face with their customers and consumers.

Given the increased anonymity of online environments and the fact that people are just as likely to live up to their obligations even when there are no witnesses, should mean that anything your business does to promote new custom (such as offering trial periods, newly published reports or exclusive software) should be an effective use of the societal rule of the ‘good old give and take’.

Either way, known or unknown, the principle of reciprocity continues to be a powerful force in persuading others.

Source:
Jerry M. Burger, Jackeline Sanchez, Jenny E. Imberi, & Lucia R. Grande. The norm of reciprocity as an internalized social norm: Returning favors even when no one finds out.

Social Influence 2008