A financial plan is a system that allows all the parts to contribute to the success or failure of the whole plan. Planning is the act of projecting forward to what we want to build financially. There are eight components for constructing a financial plan, but I want to address the two that most often get overlooked. The first, is becoming a financial consumer, and the second, is defining the purpose of each goal. In the purchasing process, as a financial consumer, emotions and logic play a major role. These can be boiled down to fear and greed. These create internal conflict during the purchasing process. Advertisers focus more on the sizzle than the steak to get you to buy. They want to stir your emotions and mitigate your logic. This explains why the most common phrases used to sell products are financial loss and performance. Knowing what you want makes it easier to filter through the sizzle and find the steak. Only then will the planning process take on clarity instead of emotions.
In order to achieve your financial plan you have to purchase products that meet the purpose defined. One purpose in a financial plan is income replacement, so you no longer need to work for income. A Single Premium Immediate Annuity (SPIA) is one consideration to provide passive income. By definition, a SPIA is a contract with an insurance company to which you pay a lump sum or premium, and in return, the insurance company promises to pay you a specific amount monthly for the remainder of your life.
By definition, you can now determine if a SPIA fits in your financial plan. If the goal is to create income from your accumulated money to replace your need to work for monthly income, then a SPIA fits. It will produce immediate income for the remainder of your life.
The details of the product are where your emotions take over. But thankfully, a SPIA contract has limited options and each is very definable in conjunction with your purpose. This is where you have to ask yourself questions. Do you want the income for both yourself and your spouse? Do you want the income to last for your joint lives? Do you want the income stream to account for inflation? Do you want the money to go to a named beneficiary if you die prematurely? It is important to define exactly what you want from the contract to determine if it fits your purpose.
It is important to define the advantages of a SPIA: guaranteed lifetime income, options for how the income is structured (single or joint), and customization of the income relative to inflation. For many, the major advantage of a SPIA is the pure transfer of risk. You transfer the risk of managing your money to the insurance company in exchange for the guaranteed monthly income. If the transfer of risk, in exchange for guarantees, satisfies your logical and emotional thought process, then a SPIA may be a perfect fit.
It is equally important to define the disadvantages of a SPIA: the biggest drawback is the lack of liquidity. You transfer a lump sum of money to the insurance company for guaranteed monthly income payments. This brings up the issue of fear and greed. Can you emotionally make that decision? And, can you logically and financially make that decision? If the answer is “no” you need to find another way to address your income needs. If you want to take on the risk of managing your own money to generate income then a SPIA contract will not agree with your logical and emotional needs.
Weighing out the advantages and disadvantages is part of the process of being a financial consumer. Knowing your purpose makes the process of achieving your financial plan doable. If you fail to pacify both sides of your brain the final decision will be impossible. If you allow one side to dominate more than the other you will make poor decisions. Know what you want, define your purpose, learn the
details, and balance the emotional and logical sides of the decision. Most importantly, don’t allow fear or greed to be the determining factor. Buy the steak because it fits your needs and desire… not the sizzle.
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