A single premium deferred annuity is a contract with an insurance company. You fund the account with a single lump sum payment, and the money you invest grows over time at a fixed or variable rate. When the annuity matures, it provides a steady income stream.

This account can offer stability, tax-deferred growth, and principal protection. So, these financial instruments have become increasingly popular among long-term investors and retirement planners.

Read on to learn what a single premium deferred annuity is and whether it’s a good option for your retirement strategy.

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How does a single premium deferred annuity work?

As with other annuities, a single premium deferred annuity has two phases: Accumulation and annuitization. Here’s how they work.

Accumulation phase

The accumulation phase is a fixed period that starts when you enter the contract and lasts until distributions begin. After signing, you’ll send the insurance company a lump-sum purchase — you can’t make flexible contributions to an SPDA. Then, your initial investment, or principal, will accumulate interest.

SPDAs are tax-deferred annuities, so you won’t pay taxes until you start taking withdrawals. This allows more of your funds to remain in the annuity, where they can continue growing.

Imagine you invest $10,000 in a 10-year fixed annuity with a 5% annual interest rate, compounded monthly. Each month, the annuity adds interest to your principal, and you earn interest on that total — a process called compounding. By the end of the accumulation phase, your annuity’s cash value will have grown to $16,470.09.

Annuitization phase

The annuitization phase begins when you convert your annuity’s accumulated value into an income stream. Depending on your contract, you may have several options, such as lifetime distributions, payments for a set period, or a lump sum withdrawal.

Once your contract matures, you can take a lump sum withdrawal, annuitize your contract and start taking withdrawals or move your annuity funds to another annuity or tax-deferred retirement product before distributions begin.

3 types of single premium deferred annuities

These are three of the most popular SPDA products.

1. Fixed SPDA

A fixed annuity grows at a steady interest rate during the accumulation phase. This type of annuity is optimal for conservative investors who want to secure fixed future payments.

2. Fixed index SPDA

A fixed index annuity links growth to a market index like the S&P 500. It often has a growth rate cap but offers principal downside protection. This means your initial investment is safe even if the market has a downturn.

For example, a fixed index SPDA may have a 5% cap on growth. These limits mean that even if the index grows to 8% , you’ll still only be credited 5%. But if it drops into the negatives, you won’t lose any of your principal. 

3. Variable SPDA

Market performance dictates a variable annuity’s rate of return. So, your growth potential rises with the market, but so does your exposure to market downturns. 

Single premium deferred annuity: Pros and cons

As with any investment, SPDAs have pros and cons. Here are the top things to consider before investing in one.

Pros of SPDAs

• Tax-deferred growth: SDPA taxes aren’t due until you start receiving payments. At that point, the IRS taxes your withdrawals as ordinary income. By deferring taxes, you keep more of your money working for you upfront, helping enhance compound growth over time compared to a taxable account.
• Guaranteed income: After the accumulation phase begins, you'll receive guaranteed payments. You decide the duration of your payments when you set up your initial contract (e.g., period certain, single life, joint and survivor, etc.).
• Principal protection: Fixed and fixed index SPDAs protect your investment against market downturns. 
• Single payment simplicity: You don’t need to make additional contributions after the initial lump sum premium.

Cons of SPDA

• Inflexibility: Unlike a flexible premium deferred annuity (FPDA), you can’t contribute to an SPDA after the initial contribution. If you can’t afford the minimum deposit amount for an SPDA, you may want to consider an FPDA. 
• Limited liquidity: Early withdrawals usually result in surrender charges. Additionally, the IRS charges a 10% early withdrawal tax penalty if you withdraw your money before age 59½, with limited exceptions.
• Fees: Some SPDAs, especially variable annuities, carry higher management and administrative fees.

Tax advantages of SPDAs

If you purchase a single premium deferred annuity, you won’t have to pay income taxes on your investment until you start collecting your annuity payments. Tax-deferred growth means more money will stay in the annuity during the accumulation phase.

How you’re taxed depends on whether you purchased a qualified or non-qualified annuity:

• Qualified annuities: You invest pre-tax dollars into these annuities. While this leaves more funds in your account to grow, you’ll also owe taxes on both the interest and principal when you start taking withdrawals.
• Non-qualified annuities: You purchase non-qualified SPDAs with after-tax money, so you only pay income taxes on your earnings during the distribution period.

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Single premium deferred annuity vs. flexible premium immediate annuity

If you're considering an annuity, it's helpful to know how SPDAs and flexible premium immediate annuities (FPIAs) work, especially in terms of payment structure and income timing:

• SPDAs: You purchase SPDAs with a lump-sum payment, and the account can grow (depending on the type of annuity) for several years before distributions begin.
• FPDAs: FPDAs allow you to make multiple contributions over time and your payments begin at a later date. 

FAQ

What happens when an SPDA matures?

When an SPDA matures, it enters the payout phase and you can elect to begin taking  regular income payments to you based on the contract terms. If you’re not ready to start receiving distributions, you can often roll over the funds into another annuity or a different retirement vehicle to continue growing your money.

Is an SPDA insured by the FDIC?

No — the FDIC doesn’t insure annuity products. Instead, SPDAs rely on the financial strength of the company issuing them. 

Can you lose money with an SPDA?

Fixed and fixed index SPDAs protect your principal, but variable annuities can put your investment at risk during down markets. Additionally, all annuities are subject to inflation risk. If prices go up, the spending power of your money decreases. So, while you might have a bigger balance when your annuity matures, your funds won’t go as far.

Secure guaranteed income with Gainbridge

If an SPDA’s guaranteed income model appeals to you, consider contributing to a Gainbridge annuity. We offer multiple online annuity products that provide guarantted growth, and consistent income, sometimes even for life. With no hidden fees or commissions and a 30-day free look period, you can always find the right annuity for you at Gainbridge.

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This communication / article is for informational / educational purposes only.

It is not intended to provide, and should not be interpreted as individualized investment, legal, or tax advice. For advice concerning your own situation, please consult with your appropriate professional advisor.

The Gainbridge^® digital platform provides informational and educational resources intended only for self-directed purposes.

Annuities issued by Gainbridge Life Insurance Company located in Zionsville, Indiana. Guarantees are subject to the financial strength and claims paying ability of the issuing insurance company.