6.2 Fixed and Immediate Annuities

Fixed Annuities: Guaranteed and Conservative

A fixed annuity is held in the insurer's general account and carries the insurer's full guarantee. The company assumes the investment risk; the owner receives a guaranteed minimum interest rate during accumulation and a fixed, level dollar payment during payout. Because there is no market risk to the consumer, a producer needs only a life insurance license to sell fixed annuities — no securities registration is required.

Fixed annuities credit two interest rates: a guaranteed minimum rate stated in the contract (the floor the insurer can never go below) and a current rate the insurer actually declares, which is typically higher and reflects current portfolio yields.

The Purchasing-Power Trade-off

The price of safety is inflation risk. Because the payment is fixed in dollars, its real purchasing power erodes as prices rise over a long retirement. A $1,000 monthly check buys far less after 20 years of inflation. The exam frames this as the central weakness of fixed annuities: the dollar amount is guaranteed and level, but the real value declines. Variable and indexed annuities exist largely to address this inflation problem (at the cost of guarantees).

Immediate Annuities (SPIA)

An immediate annuity begins income payments within about one payment interval of purchase — typically within 12 months, often 30 days to one year. Because there is no real accumulation period, immediate annuities are nearly always funded with a single premium, hence Single Premium Immediate Annuity (SPIA).

A SPIA is the classic 'pension you buy yourself': hand the insurer a lump sum (e.g., a 401(k) rollover or inheritance) and receive a guaranteed paycheck for life starting now. There is no surrender value to speak of once payments begin — the lump sum has been irrevocably exchanged for income.

Immediate vs. Deferred Timeline

Trap: 'Immediate' refers to when income begins, not when the contract is issued. An annuity bought today that begins paying in 6 months is still an immediate annuity; one that begins in 5 years is deferred even if purchased with one lump sum (that would be a Single Premium Deferred Annuity, SPDA).

Worked Numeric: The Exclusion Ratio

When a non-qualified immediate annuity pays income, each check is part return of principal (tax-free) and part earnings (taxable). The tax-free portion is set by the exclusion ratio:

Exclusion Ratio = Investment in the Contract / Expected Return

Example: An owner pays $100,000 for a life annuity. Based on her life expectancy, the insurer projects an expected return of $200,000. The exclusion ratio is $100,000 / $200,000 = 50%.

• If she receives $1,000/month, then $500 (50%) is a tax-free return of principal and $500 is taxable interest.
• Once she has recovered her full $100,000 basis (she outlives the table), payments become fully taxable.
• If she dies early, the unrecovered basis is deductible on her final return.

Equity Indexing on the Fixed Side

Some carriers add a market value adjustment (MVA) to fixed deferred annuities: surrendering early when interest rates have risen reduces the surrender value (and vice-versa), shifting interest-rate risk to the owner. The MVA applies only on early surrender and disappears at the end of the surrender period. This is still a fixed annuity for licensing purposes — no securities license needed — but the owner bears some interest-rate exposure on early exit.

Pure Life vs. Refund Math on a SPIA

Return to settlement choices in the immediate context. Suppose the SPIA in the example would pay $1,800/month under Life Only but only $1,650/month under Life with 10-Year Period Certain. The $150 difference is the price of the guarantee.

• Under Life Only, if the annuitant dies in month 13, the insurer keeps the remaining principal — the beneficiary gets nothing.
• Under the 10-Year Period Certain, if death occurs in year 4, the beneficiary collects the remaining ~6 years of $1,650 payments.

The exam wants you to connect the smaller check to the survivor guarantee, and the larger check to forfeiting it.

Free-Look and Annuity Disclosure

Like life policies, annuities carry a free-look period (commonly 10 to 30 days, longer — often 30 days — for senior buyers) during which the owner may return the contract for a full refund of premium. Insurers must also deliver an annuity disclosure / Buyer's Guide describing fees, surrender charges, and how interest is credited.

Exam Tip: A SPIA's free-look refund is the owner's last clean exit; once payments begin and the look period passes, the lump sum is irrevocably annuitized. Producers selling to seniors face heightened suitability and disclosure duties under the NAIC Suitability in Annuity Transactions Model Regulation.

Fixed Annuity Guarantees in Detail

A fixed annuity makes three layered promises during accumulation that the exam expects you to separate:

• Guaranteed principal — the deposited amount cannot decline due to market activity; it sits in the general account.
• Guaranteed minimum interest rate — a contractual floor (often 1%-3%) the insurer can never credit below, even if portfolio yields collapse.
• Current (declared) rate — the higher rate the insurer actually credits, reset periodically at the company's discretion above the floor.

During payout, the annuity table locks the dollar payment for life. This stacking of guarantees is exactly why the insurer — not the owner — carries the investment risk, and why a fixed annuity needs no securities license to sell.

Comparing Income Streams

When advising a retiree, contrast a SPIA life-only payout with simply drawing down savings. The SPIA pools longevity risk: those who die early fund those who live long, so the insurer can guarantee a check the client cannot outlive — something a self-managed account cannot promise. The cost is liquidity (the lump sum is gone) and inflation exposure (the dollar payment is level).

Trap: Candidates confuse 'guaranteed for life' with 'guaranteed against inflation.' A fixed SPIA guarantees the number of dollars, never their purchasing power. Bundling a cost-of-living rider raises the cost or lowers the starting payment.