6.2 Fixed and Immediate Annuities
Key Takeaways
- Fixed annuities are general-account products: the insurer bears investment risk; only a life license is needed to sell.
- Two rates apply: a guaranteed minimum (1-3%) floor and a higher current declared rate the insurer can change.
- The main weakness of fixed annuities is inflation/purchasing-power risk.
- A MYGA locks the rate for 3-10 years (like a CD); a traditional fixed annuity resets annually.
- An immediate annuity (SPIA) uses a single premium and begins income within ~12 months with no accumulation phase.
Fixed and Immediate Annuities
A fixed annuity guarantees principal and a minimum rate of interest. The insurer holds the premiums in its general account - invested conservatively in bonds, mortgages, and real estate - and the insurer bears the investment risk. Because the company guarantees the return, a fixed annuity is a general-account product and requires only a life insurance license to sell (no securities registration).
Fixed annuities credit two rates:
- Guaranteed minimum rate - typically 1-3%; the credited rate can never drop below this floor.
- Current (declared) rate - usually higher than the guarantee; the insurer can change it periodically based on portfolio performance.
Trade-Offs and MYGAs
The strength of a fixed annuity is safety: principal protection and predictable, guaranteed growth. The weakness is purchasing-power (inflation) risk - a fixed return may fail to keep pace with inflation, eroding real value over a long retirement.
A Multi-Year Guaranteed Annuity (MYGA) locks the declared rate for a set term (commonly 3-10 years), functioning much like a bank CD but with tax deferral. A traditional fixed annuity, by contrast, resets its current rate annually.
| Feature | Traditional Fixed | MYGA |
|---|---|---|
| Rate guarantee period | Resets annually | Locked 3-10 years |
| Best analogy | Savings account | Bank CD |
| Risk bearer | Insurer | Insurer |
Classifying Annuities by When Income Begins
The immediate vs. deferred distinction is based on when income payments start, while single vs. flexible is based on how premium is paid.
- Immediate annuity (SPIA) - purchased with a single premium; income begins within one payment interval, generally within 12 months of purchase. There is no accumulation phase.
- Deferred annuity - income is postponed to a future date, allowing tax-deferred accumulation.
Because an immediate annuity must be bought with one lump sum, the only valid combinations are SPIA (single-premium immediate) and either SPDA or FPDA for deferred. A flexible-premium immediate annuity does not exist - you cannot make ongoing payments into a contract that is already paying you income.
Single Premium Immediate Annuity (SPIA) Mechanics
A SPIA is the classic retirement "income now" vehicle. A retiree hands the insurer a lump sum and receives a guaranteed paycheck. Because there is no accumulation phase, SPIAs offer the highest payout rates for a given premium relative to deferred contracts annuitized later.
Worked example: A 70-year-old deposits $300,000 in a SPIA with a life-only option paying $1,850 per month. If she lives 20 years she collects $1,850 x 240 = $444,000 - far more than her premium. If she dies after 3 years, a pure life-only SPIA stops paying and the insurer keeps the balance. This is why payout-option selection (life-only vs. period certain) is critical and is covered in the payout-options unit.
Why retirees choose a SPIA — and its trade-off
The defining strength of a Single Premium Immediate Annuity is mortality pooling: because annuitants who die early subsidize those who live long, a SPIA can pay more guaranteed lifetime income per dollar than any self-managed withdrawal strategy that must hedge against living to 100. The defining weakness is loss of liquidity and inflation exposure. Once a lump sum is annuitized under a life option the election is irrevocable; the retiree has traded a reclaimable balance for a paycheck.
A level fixed payment also loses purchasing power over a 25-year retirement, which is why suitability discussions pair a SPIA with other inflation-sensitive assets rather than committing all savings to one contract.
Comparing the general-account products
| Feature | Traditional fixed | MYGA | SPIA |
|---|---|---|---|
| When income starts | Deferred | Deferred | Immediate (≤12 mo) |
| Rate behavior | Resets annually | Locked 3–10 yrs | N/A (income fixed) |
| Liquidity | Surrender schedule | Surrender schedule | None after annuitization |
| Bank analogy | Savings account | CD | Pension paycheck |
All three live in the insurer's general account, all guarantee principal, and all are sold under a life-only license. The exam's favorite trap is to offer a "flexible-premium immediate annuity" as an answer choice — it cannot exist, because you cannot keep paying premiums into a contract that is already paying you income. Pair the funding method (single vs. flexible) only with the deferral type that makes logical sense: SPIA, SPDA, or FPDA.
Worked rate-floor illustration
Suppose a traditional fixed annuity guarantees a 3% minimum rate and currently declares 5%. In a year when the insurer's bond portfolio underperforms, it may reduce the declared rate — but never below the 3% contractual floor, so a credited rate of 2% is impossible regardless of market conditions. On a $50,000 balance, the worst-case guaranteed growth is $50,000 × 3% = $1,500, while the current declared rate would credit $50,000 × 5% = $2,500. This floor is the safety the product sells, and it is the reason a fixed annuity is positioned for conservative retirees who cannot tolerate principal loss.
The cost of that safety is purchasing-power risk: if inflation runs at 4%, a 3%-floor year actually loses real value, which is why producers rarely recommend committing an entire nest egg to a single fixed contract.
In a fixed annuity, who bears the investment risk and what license is required to sell it?
Which statement correctly describes an immediate annuity?