9.3 Immediate vs. Deferred and Single vs. Flexible Premium
Key Takeaways
- Immediate annuities (SPIAs) use a single premium and begin income within about one year, with no accumulation phase.
- Deferred annuities delay income, accumulate value tax-deferred, and may be single (SPDA) or flexible premium (FPDA).
- A flexible premium annuity is always deferred; a flexible premium immediate annuity cannot exist.
- Match the fact pattern: lump sum + income now = SPIA; periodic deposits + income later = FPDA.
- Deferred annuities impose declining surrender charges, usually with a 10% annual free-withdrawal allowance.
Beyond the investment classification (fixed/indexed/variable), annuities are categorized by when income begins and by how premium is paid. These two axes combine to produce the named product types the exam expects you to identify from a fact pattern.
Classification by When Income Begins
Immediate Annuities
A Single Premium Immediate Annuity (SPIA) is purchased with a single lump-sum premium, and income payments begin within one payment interval — typically within one year, often within 30 days to one month. There is essentially no accumulation phase. SPIAs are used to convert a lump sum (a retirement rollover, inheritance, or settlement) into immediate guaranteed income.
Deferred Annuities
A deferred annuity delays income to a future date, allowing the contract to accumulate value tax-deferred during the waiting period. Income may not begin for years or decades. Deferred annuities have a full accumulation phase and can later be annuitized or surrendered. The exam distinction: immediate = income within ~1 year, single premium only; deferred = income later, single or flexible premium.
| Type | Premium | Income Begins | Accumulation Phase |
|---|---|---|---|
| SPIA (immediate) | Single lump sum | Within ~1 year | None |
| SPDA (deferred) | Single lump sum | Future date | Yes |
| FPDA (deferred) | Flexible/periodic | Future date | Yes |
Classification by How Premium Is Paid
Single Premium
A single premium annuity is funded with one lump-sum payment and no further contributions are allowed. This funds both SPIAs (immediate) and SPDAs (single premium deferred annuities). A retiree rolling over a 401(k) balance commonly uses a single-premium contract.
Flexible Premium
A Flexible Premium Deferred Annuity (FPDA) allows the owner to make periodic, variable contributions over time — more, less, or skip payments within contract limits. Because contributions occur over time, a flexible premium annuity is always deferred; you cannot pay flexible premiums into an immediate annuity, since income would have to start before the premiums are complete.
The Key Logical Trap
There is no such thing as a 'flexible premium immediate annuity.' An immediate annuity must be single premium, because payments begin almost at once and the full purchase amount must be on hand. Conversely, a flexible premium contract is always deferred. Expect a question that lists 'flexible premium immediate annuity' as a distractor — it is impossible.
Scenario: Matching the Need
- A 66-year-old wants income starting next month from a $300,000 lump sum → SPIA (single premium immediate).
- A 45-year-old wants to contribute $300/month until retirement → FPDA (flexible premium deferred).
- A 60-year-old rolls over $200,000 but wants income to start at 70 → SPDA (single premium deferred).
Surrender Charges and Liquidity
Deferred annuities carry surrender charges during an early surrender period (often 5 to 10 years) to recoup the insurer's acquisition costs. A common structure declines annually, e.g., 7% in year 1, 6% in year 2, and so on to 0%. Most contracts allow a free withdrawal of up to 10% of value per year without a surrender charge. Surrendering a $100,000 contract in year 2 at a 6% charge costs $6,000 in surrender penalties (separate from the 10% IRS penalty if under 59½).
Two independent axes: when income starts, how it is funded
Annuities are classified on two separate dimensions. Combining them correctly is the heart of this topic:
| Single premium | Flexible premium | |
|---|---|---|
| Immediate | SPIA — one lump sum, income within ~1 year | Does not exist |
| Deferred | SPDA — one lump sum, income later | FPDA — periodic deposits, income later |
An immediate annuity (SPIA) has no accumulation phase; you hand over a lump sum and begin receiving income within about a year. A deferred annuity has an accumulation phase and may be funded with a single premium (SPDA) or with flexible periodic deposits (FPDA).
The impossible combination and surrender charges
The single most-tested fact here: a flexible-premium immediate annuity cannot exist. You cannot make ongoing deposits into a contract that is already paying you income from day one — so all flexible-premium annuities are deferred.
Match the fact pattern:
- Lump sum + income now → SPIA (single premium immediate)
- Lump sum + income later → SPDA (single premium deferred)
- Periodic deposits + income later → FPDA (flexible premium deferred)
Surrender charges: Deferred annuities impose a declining surrender charge schedule (a 'surrender period,' often 6-10 years) to discourage early withdrawal and recover the insurer's acquisition costs.
Most contracts allow a free-withdrawal corridor — commonly 10% of value per year — without a surrender charge. Withdrawals still face LIFO income tax and the 10% pre-59½ penalty regardless of the surrender-charge waiver.
A 47-year-old wants to contribute varying amounts each month toward retirement income that will start at age 67. Which annuity structure fits?
Which statement about immediate annuities is correct?