4.2 Types of Annuities

Three Ways to Classify an Annuity

Every annuity question can be answered by sorting the contract along three axes: how it is funded, when income starts, and how interest is credited. Learn the axes and the rest falls into place.

Axis 1: Funding — Single vs Flexible Premium

• Single Premium: funded with one lump-sum deposit. No further payments are allowed.
• Flexible Premium: funded with a series of periodic deposits over time. The owner can vary the amount and timing within limits.

A critical logical link: because a flexible-premium contract is still receiving deposits, it must be a deferred annuity — you cannot begin paying out a contract you are still funding. Therefore there is no such thing as a flexible-premium immediate annuity. Single-premium contracts, by contrast, can be either immediate or deferred.

Axis 2: Payout Start — Immediate vs Deferred

A SPIA (Single Premium Immediate Annuity) is bought with one lump sum and starts income right away — ideal for a retiree who wants to convert a 401(k) rollover into a paycheck immediately. A deferred annuity accumulates value first, then annuitizes later; it is the only type that has an accumulation phase and the only type that can be flexible premium.

Axis 3: Interest Type — Fixed, Variable, Indexed

This is the most heavily tested axis and the one that determines what license you need to sell the product.

Fixed Annuity

The insurer credits a declared interest rate that can never fall below the contract's guaranteed minimum rate. The insurer bears the investment risk and guarantees both principal and a minimum return. Money is held in the insurer's general account. A fixed annuity can be sold with only a life insurance license.

Variable Annuity

Premiums are invested in separate-account subaccounts (mutual-fund-like portfolios chosen by the owner). The value — and the eventual payments — rise and fall with market performance, so the owner bears the investment risk. Because a variable annuity is a security, the producer must hold both a life insurance license and a FINRA securities registration (typically Series 6 or Series 7) and the company must deliver a prospectus. This dual-license requirement is a guaranteed exam point.

Indexed (Fixed Indexed) Annuity

An indexed annuity credits interest linked to an external index such as the S&P 500, but with built-in limits:

• Cap rate: the maximum interest credited in a period (e.g., index rises 12% but the 6% cap limits the credit to 6%).
• Participation rate: the percentage of the index gain credited (e.g., 80% participation on a 10% gain credits 8%).
• Floor: the guaranteed minimum, usually 0%, so the owner never loses principal to a market decline.
• Market Value Adjustment (MVA): an adjustment to surrender value if the owner cashes out early, tied to interest-rate movements — it can increase or decrease the amount.

Despite the index link, an indexed annuity is generally treated as a fixed annuity, not a security, so a securities registration is usually not required to sell it.

Guaranteed Living Benefits and Bonus Annuities

Modern deferred annuities (especially variable) add optional guaranteed living benefit riders, paid for with extra charges:

• GMIB (Guaranteed Minimum Income Benefit): guarantees a minimum future annuitization income regardless of market losses.
• GMWB (Guaranteed Minimum Withdrawal Benefit): guarantees the owner can withdraw a set percentage of the benefit base each year until the full amount is recovered, even if the account value drops to zero.

A bonus annuity credits an upfront premium bonus (e.g., 5% added to the first-year deposit). The trade-off is usually a longer surrender-charge schedule and sometimes higher fees, so suitability — covered in 4.3 — is a major concern with bonus and replacement sales.

General Account vs Separate Account

A recurring exam distinction is where the premiums are held, because it determines who bears risk and what license applies.

• General account: backs fixed and indexed annuities. The insurer invests conservatively, guarantees principal and a minimum rate, and bears the investment risk. No securities registration is needed.
• Separate account: backs variable annuities. Premiums fund subaccounts the owner selects; the owner bears the investment risk. Separate-account products are securities regulated by the SEC and FINRA in addition to the state insurance department — this is dual regulation.

Putting the Axes Together

A single contract is described by all three axes at once. Reading a contract name tells you a lot:

Notice there is no 'flexible premium immediate annuity' row — that combination is impossible because you cannot keep funding a contract that is already paying out. When an exam answer choice pairs flexible premium with immediate income, it is wrong by definition.