6.2 Fixed and Immediate Annuities

Fixed Annuities

A fixed annuity guarantees both the safety of principal and a minimum rate of interest. The insurer invests premiums in its general account (conservative bonds and mortgages) and bears all investment risk. Because the insurer guarantees the rate, the agent needs only a life insurance license to sell a fixed annuity — no securities registration is required.

Fixed annuities pay two interest rates. The guaranteed rate is the contractual floor the insurer can never pay below (e.g., 1%–3%). The current rate is the higher rate the insurer credits based on actual portfolio earnings; it is reviewed periodically. The owner always receives the greater of the two.

Level Benefit and Purchasing-Power Risk

Because a fixed annuity pays a level (fixed) dollar benefit, the annuitant knows exactly what each check will be — a major selling point for conservative retirees. The trade-off is purchasing-power risk (inflation risk): a level $1,000 monthly check buys less every year as prices rise. Over a 20-year retirement, inflation can cut real spending power by half or more. This is the single most-tested disadvantage of fixed annuities, and it is precisely the problem variable annuities were designed to address.

Immediate Annuities (SPIA)

A Single Premium Immediate Annuity (SPIA) is purchased with one lump sum and begins paying income within one payment interval — typically the first payment arrives 30 days to one year after purchase. Because there is no accumulation, an immediate annuity has no surrender value once annuitized.

SPIAs are the classic tool for a retiree who has a lump sum (a rollover, an inheritance, a maturing CD) and wants to convert it immediately into guaranteed lifetime income. They are also used to fund structured settlements for lawsuit or workers'-compensation awards.

A SPIA can be issued as a fixed immediate annuity (level dollar checks) or a variable immediate annuity (checks that fluctuate with subaccount performance). The defining trait is timing, not investment type: income begins within one payment interval, with no meaningful accumulation phase to grow the deposit before payout.

Annuitization Payout Options

When a contract annuitizes, the owner selects a settlement option that fixes the duration and survivor protection:

Trap: Pure life pays the highest monthly amount precisely because it offers no death-benefit guarantee — the insurer keeps any unpaid balance if the annuitant dies early. Adding period-certain or refund features lowers each check.

Worked Payout Comparison

Suppose $200,000 annuitizes for a 65-year-old male:

• Life only: $1,200/month — highest, but $0 to heirs at death.
• Life with 10-year certain: $1,100/month — if he dies in year 4, the beneficiary collects the remaining 6 years (72 payments).
• Joint and 100% survivor (spouse age 63): $980/month — lowest, because two lives stretch the payout.

The more guarantees you add and the more lives you cover, the smaller each payment, because the insurer expects to pay out longer. The factors that drive payment size are the annuitant's age and gender (older annuitants and males get larger checks due to shorter life expectancy), the payout option, the account value, and the insurer's assumed interest rate.

Non-Life Payout Options and Frequency

Not every settlement option is tied to a lifetime. Two important non-life options:

• Fixed-period (period certain) option — pays a set income for a chosen number of years (e.g., 15 years); if the annuitant dies, the beneficiary receives the remaining payments. The duration is fixed, the payment amount varies with the balance.
• Fixed-amount option — pays a fixed dollar amount each period until both principal and interest are exhausted; here the amount is fixed and the duration varies.

These options do not guarantee lifetime income — they can run out — so they trade off longevity protection for a known schedule. Income can be paid monthly, quarterly, semiannually, or annually; less frequent payouts leave more on deposit earning interest, so they pay slightly more in total.

Single vs. Joint Annuitants

A straight life annuity covers one annuitant. Joint life stops payments at the first death of two annuitants (rare, used where income is no longer needed after one dies). Joint and survivor continues — at 100%, 66⅔% (joint and two-thirds), or 50% (joint and one-half) — to the survivor.

Trap: Do not confuse joint life (ends at first death) with joint and survivor (continues to the survivor). A "joint and ½ survivor" reduces the check to 50% after the first annuitant dies, which is why the initial payment under a joint-and-survivor option is lower than a single-life payout — the insurer expects to pay across two lifetimes.

SPIA Payout Math and the Exclusion Ratio

A single-premium immediate annuity (SPIA) is funded with one lump sum and begins payments within one annuity period (usually within 12 months); there is no accumulation phase. A fixed annuity guarantees both principal and a minimum interest rate, putting investment risk on the insurer, and is backed by the general account.

The exclusion ratio determines how much of each payment escapes tax when the annuity was bought with after-tax dollars (non-qualified):

Exclusion ratio = Investment in the contract / Expected total return.

Worked example: a $100,000 SPIA pays $600/month ($7,200/year) for a life expectancy of 20 years. Expected return = $7,200 x 20 = $144,000. Exclusion ratio = $100,000 / $144,000 = 69.4%. So about $5,000/year is a tax-free return of principal and about $2,200/year is taxable interest. Once the entire basis has been recovered (after 20 years here), all further payments are fully taxable; if the annuitant dies early, the unrecovered basis is deductible on the final return. This exclusion-ratio mechanic, the insurer-bears-risk rule, and the single-premium/immediate-start definition are the three most-tested points.