An annuity is an agreement between you and an insurance company. You’ll purchase the annuity with premiums and in exchange, the insurer will pay your money back in the future, usually in the form of a regular income.
When you purchase an annuity, you’ll have the option to pay your premiums with one payment, or multiple payments. Choosing between these two payment options will depend on your budget needs and investment goals.
How do annuity premiums work?
Premiums are the payments you make to buy an annuity contract. Premiums are also what fund your annuity. When the insurer starts paying you an income from your annuity, the pay you receive back will be based on the premiums you paid into it, plus any growth.
You can pay your premiums with qualified funds or non-qualified funds.
Qualified annuities are purchased with pre-tax dollars that are usually held in retirement accounts like a 401(k) plan or an individual retirement annuity (IRA). You won’t pay taxes on any of the funds in a qualified annuity until the annuitization phase begins. During annuitization, the full amount of your income payments will be taxed as earnings.
Non-qualified annuities are purchased with money that’s already been taxed. When you start withdrawing money from your annuity during annuitization, you won’t have to pay taxes again on the principal you paid, but you’ll have to pay taxes on any growth. [1]
A good rule of thumb to remember is that with annuities, you’ll only need to pay taxes on your money once — either before you purchase the annuity or after. Likewise, any growth will also be taxed as income before you receive a payment.
Learn more about how annuities work
What is a single premium annuity?
A single premium annuity is simply an annuity contract purchased with one premium payment. It doesn’t matter if you use qualified or non-qualified funds, or if you set up your annuity to pay you for a period of time or for the rest of your life.
Single premium annuities can look different in many ways, but share the defining feature of being purchased with a single premium payment.
Learn more about immediate annuities
How do single premium annuities work?
With a single premium annuity, you’ll purchase your contract using one payment. Often people fund these annuities with their retirement savings, but it’s also common to purchase a single premium annuity with some sort of windfall, like receiving an inheritance or winning a legal settlement.
You can set up your single premium annuity to pay you an income in two different ways.
Single premium immediate annuity (SPIA) will use your premium payment to set up an income that pays you right away. SPIAs will issue your first payment within 12 months of purchasing the contract.
Single premium deferred annuity (SPDA) invests your premium and allows your money to grow before disbursing it back to you as an income. With a deferred annuity, you’ll wait at least one year before getting paid. However, most people wait several years or even decades before collecting payments from a deferred annuity.
Learn more about immediate vs. deferred annuities
What is a flexible premium annuity?
A flexible premium annuity allows you to fund your annuity with several payments. You can purchase this type of contract with payments of different amounts, paid at different times. Once you’ve put all the money you want into your annuity, you can determine when and how the annuity will disperse the money back to you.
Most people have their flexible premium annuities pay them an income at some point in the future.
What is the impact of interest rate changes on your annuity?
How do flexible premium annuities work?
With a flexible premium annuity, you’ll make one premium payment to start the annuity. After that, you can contribute additional premiums of varying amounts and varying times until you’ve deposited all the money you want in your contract.
Once your annuity is fully funded, you’ll be able to start collecting income payments from it.
Can you lose money in an annuity?
Single premium vs. flexible premium annuities: Comparing the main differences
Feature | Single premium annuity | Flexible premium annuity |
|---|---|---|
Premiums | One payment | Multiple payments |
Accumulation period | Not required, annuities can be immediate or deferred | Required, annuities must be deferred |
Annuitization | Annuities can be paid out as one lump sum, for a period of time, or for life | Annuities can be paid out as one lump sum, for a period of time, or for life |
Penalty for early withdrawals | Yes, especially during surrender period | Yes, especially during surrender period |
Surrender period | Varies, typically around seven years | Varies, typically around seven years |
Investment options | Fixed, indexed, or variable | |
Tax-deferred options | Yes | Yes |
Rider & benefit options | Varying options | Varying options |
Learn more about other types of annuities
Can annuities be used as a collateral for a loan?
Single premium annuities vs. flexible premium annuities: Pros & cons
Both single premium annuities and flexible premium annuities come with benefits and drawbacks that you should consider before deciding which type of contract is best for you.
Pros of single premium annuities
Can help you manage a large sum of money. A single premium annuity is one of the most straightforward ways to turn a large sum of money into a stream of income.
More potential for compound interest. Purchasing a single premium annuity will allow your money to grow over time, and your annuity will be better able to grow with compound interest compared to flexible premium annuities.
Cons of single premium annuities
Lack of money for other investments. If you put your money in a single premium annuity, it means you’re giving up the chance to invest your money in more lucrative ways.
Potential surrender charges. If your needs change and you need to withdraw money from your annuity before the surrender period ends, your withdrawals will be subject to surrender charges, which can be as much as a 10% penalty. [2]
Do annuities affect financial aid and other benefits?
Pros of flexible premium annuities
The account value grows tax-deferred. You won’t pay taxes on the growth of your flexible premium annuity until you withdraw the funds. This is especially helpful if you’re using your annuity premiums to save money for the future. [3]
Allows for savings over time. One of the most attractive parts of a flexible premium annuity is that you can contribute several payments before the annuity is fully funded.
Can you withdraw money from your annuity?
Cons of flexible premium annuities
Slower growth. Because you’ll be putting less money in your annuity at first, it means your money will have less time to grow before you start collecting an income.
Expensive fees. If you deviate from the annuity’s pay schedule and need to make an early withdrawal, you could face expensive fees, especially if you make a withdrawal within the surrender period.
Are annuities a good investment?
How to decide between single premium & flexible premium annuities?
Deciding between a single premium annuity and a flexible premium annuity ultimately comes down to how you want to pay for your annuity, and how you want your money to grow.
Consider a single premium annuity if you have a large sum of money that you’d like to convert into an income. You can collect these income payments immediately or defer them to a time in the future. The money in your annuity will grow at a reliable rate and benefit from compounding interest.
Alternatively, a flexible premium annuity could be a good option for you if you know you want to use an annuity to create a source of income in the future, but don’t have all of the funds you’d want to finance this annuity available and liquid. A flexible premium annuity allows you to establish your annuity and then fund it over time.
If you’re unsure which type of annuity would be best for you, speak with a financial advisor who can offer you transparent, unbiased advice.
How does an annuity fit into your overall retirement plan?
