Should You Wait to Buy a SPIA?

Advisors may be reluctant to recommend single-premium immediate annuities (SPIAs) with interest rates currently so low. It may be better to wait for rates to rise, which will bring more attractive SPIA pricing. But that leaves the question about how long we will wait for better pricing. In this article, I'll show how the decision to delay can turn out well or poorly, depending on the timing and size of rate increases.

Factors to consider

Deciding whether to buy a SPIA now or later is like the deciding when to refinance a mortgage – doing so requires making assumptions about an unknown future. The SPIA decision involves either explicitly or implicitly assuming answers to the following:

  • When will rate increases occur? This is closely related to the question of how long it will take the economy to recover enough that we get back to a more "normal" level of interest rates. Both "known unknowns" and "unknown unknowns," to borrow the Rumsfeld expressions, will determine the eventual timing.
  • How much will SPIA pricing rates change? These are the interest rates that insurers use in their pricing, and they reflect the rates they can earn on the corporate bonds and commercial mortgages that support their fixed-income products. Changes in these rates will reflect the combination of changes in Treasury rates and the spread over Treasury bonds that insurers can earn for taking credit risk.
  • How much interest does "parked" money earn? If one decides to delay buying a SPIA, money will need to be set aside to purchase it at a later time.  The higher the returns on these funds, the less will be the penalty for waiting. Exposing those funds to too much volatility, however, might result in losses.

In order to demonstrate how these assumptions interact, I'll use a specific example. 

A typical investor

This example is based on a 65-year-old woman who wishes to generate an additional $10,000 per year in secure income. She has decided to purchase a SPIA to provide the additional income, but needs to decide whether to make the purchase now or wait for higher rates.1

There are SPIAs that pay level amounts of income and also more costly versions that provide annual inflation adjustments similar to Social Security. In this example, I’ll use the level-pay SPIAs, which are by far the more popular option. Based on rates from Income Solutions®, a SPIA paying $10,000 per year in monthly installments would cost this individual $160,000.

For this particular example, I'll start by using my own subjective estimates for the assumptions mentioned above. Later, I will show how varying these assumptions will affect outcomes.

1. When making plans to generate additional retirement income, individuals and couples should first consider when to begin receiving Social Security benefits so that they build a base of optimized Social Security before planning for other income sources. The Society of Actuaries Decision Brief, "Deciding When to Claim Social Security," available here http://www.soa.org/research/research-projects/pension/research-managing-retirement-decisions.aspx provides a summary of the issues involved and lists references for more in-depth reading. This example assumes that such Social Security planning has been completed before considering SPIA