6.2 Fixed and Immediate Annuities

Fixed Annuities

A fixed annuity credits a guaranteed minimum rate of interest and pays a fixed, guaranteed dollar amount during the payout phase. The insurer places premiums in its general account and bears all investment risk; the contract owner bears only purchasing-power (inflation) risk. Because the values are guaranteed and not tied to securities, a fixed annuity is not a security and may be sold with only a life insurance license — no FINRA registration is required.

The insurer guarantees two rates: a guaranteed (floor) rate stated in the contract that it can never pay below, and a higher current rate it may credit based on actual general-account performance. The current rate is reset periodically and can move down toward, but never below, the guaranteed floor.

Fixed Annuity Guarantees

• Guaranteed minimum interest during accumulation (e.g., a 1% contractual floor).
• Guaranteed fixed payment during payout — the dollar amount per check never changes once annuitized.
• Level purchasing power risk falls on the owner: a $1,000 monthly check buys less after years of inflation.

The key exam trap: in a fixed annuity the insurer assumes the investment risk; in a variable annuity the owner assumes it. Memorize this split.

Timing Classification: Immediate vs. Deferred

Annuities are also classified by when income begins:

An immediate annuity is funded with one lump sum and begins paying within one payment period — for monthly income, the first check arrives in about 30 days; the term SPIA (single-premium immediate annuity) is the common product name.

Worked Example — When Does Income "Begin"?

A retiree deposits $200,000 into a SPIA on June 1 and elects monthly income. The first payment is due within one payment interval — about July 1. The same $200,000 placed in a deferred annuity could sit and compound for 15 years before any payment, with all interim earnings tax-deferred.

Note that "immediate" is defined by the payment frequency, not literally same-day: with annual payments, an immediate annuity's first check could be due up to 12 months out and still qualify as immediate.

Taxation of Payout — The Exclusion Ratio

During payout, each payment from a non-qualified annuity is part nontaxable return of cost basis and part taxable interest. The split is set by the exclusion ratio:

Exclusion ratio = Investment in the contract (cost basis) ÷ Expected total return

Worked example: an owner paid $100,000 (basis) into a contract whose expected lifetime return is $200,000. Exclusion ratio = 100,000 ÷ 200,000 = 50%. Of each $1,000 monthly check, $500 is a tax-free return of principal and $500 is taxable as ordinary income.

Trap: once the annuitant lives long enough to fully recover the cost basis, all subsequent payments become 100% taxable — the exclusion ratio no longer applies.

Market Value Adjustment and the Two-Phase Structure

Many fixed deferred annuities add a market value adjustment (MVA): if the owner surrenders early, the cash value is adjusted up or down based on how interest rates have moved since purchase. If rates rose, the surrender value is reduced (the insurer's bond holdings lost value); if rates fell, it is increased. The MVA shifts interest-rate risk to the owner during the surrender period and is layered on top of any surrender charge.

Every annuity has two phases that must not be confused:

• Accumulation (pay-in) phase — premiums grow tax-deferred. Immediate annuities skip this phase entirely.
• Annuitization (pay-out) phase — the accumulated value is converted into a stream of income; the contract is "annuitized."

A key irreversibility trap: once a contract is annuitized under a life option, it generally cannot be surrendered or reversed — the owner has exchanged the lump sum for an income stream guaranteed by the insurer.

Single-Premium Immediate Annuity — Worked Cash Flow

A 70-year-old deposits $250,000 into a SPIA electing a straight life income. There is no accumulation phase; the first monthly check arrives within one payment interval (~30 days). Suppose the contract pays $1,650/month for life. If the annuitant lives 25 years, total payouts of about $495,000 far exceed the deposit — the insurer's mortality pooling (longevity risk transfer) funds the excess from annuitants who die early.

Under a pure life (straight life) option there is no refund to a beneficiary: if the annuitant dies after two payments, the insurer keeps the balance. That maximizes the monthly check but creates the largest forfeiture risk — the central trade-off the exam tests in the payout chapter.

Why Fixed Annuities Aren't Securities — The Licensing Payoff

Because a fixed annuity's principal and minimum interest are guaranteed by the insurer's general account and not tied to securities performance, it is not a security: a life insurance license alone suffices, with no FINRA registration or prospectus. Contrast this with variable and (sometimes) indexed-linked variable products that require securities registration. This "fixed = life license only" rule is among the most repeated annuity exam facts.

Single-Premium vs. Flexible-Premium Distinction

Immediate annuities are always single-premium (one lump sum, the SPIA), because income begins within one payment interval and there is no time to accept further deposits. Deferred annuities may be single-premium (SPDA) or flexible-premium (FPDA). So the exam pairing to memorize is: immediate = single premium only; flexible premium = deferred only. Asking whether a "flexible-premium immediate annuity" exists is a trick — it does not.