6.2 Fixed and Immediate Annuities

Fixed Annuities

A fixed annuity credits a guaranteed minimum rate of interest and pays a guaranteed, level dollar income during annuitization. Premiums go into the insurer's general account, where the carrier bears the investment risk and invests conservatively (bonds, mortgages). Because the insurer guarantees principal and a minimum rate, the fixed annuity is a general-account product and the producer needs only a life license - no securities registration.

Two interest rates apply during accumulation:

• Guaranteed (floor) rate - the minimum the insurer will ever credit (e.g., 1-3%), stated in the contract.
• Current (excess) rate - the actual rate declared periodically, which may exceed the floor when the insurer's portfolio performs well.

The owner receives the greater of the two. The chief drawback the exam highlights: because payments are level, fixed annuities lose purchasing power to inflation over a long retirement.

Fixed annuities are valued in dollars, not units - the contract holds a stated cash value that grows by credited interest. The insurer cannot credit below the guaranteed floor even in a poor investment year, which is precisely why the carrier (not the owner) bears the investment risk and must hold conservative reserves.

Because nothing about the product depends on securities markets, fixed annuities are exempt from SEC registration and prospectus delivery. A producer who tells a client a fixed annuity "can't lose money" is technically accurate as to principal, but should still disclose surrender charges and inflation risk to avoid an unsuitable recommendation.

Immediate Annuities (SPIA)

A Single Premium Immediate Annuity is bought with one lump sum and begins paying income within one payment interval, typically within 12 months and as soon as one month. There is no accumulation period - the contract goes straight to annuitization.

Classic use cases: a retiree rolling a 401(k) into guaranteed lifetime income, or a structured settlement funding a lawsuit award. Because annuitization is immediate, the first payment represents both return of principal and interest from day one.

Contrast with a deferred annuity, which accumulates first and may be annuitized years later. Remember: immediate annuities must be single premium - you cannot make flexible deposits into a contract that is already paying out, because the funds are being liquidated rather than gathered.

Annuity Payout (Settlement) Options

At annuitization the owner selects how income is paid. These options trade off payment size against survivor protection.

Life Only pays the most because the insurer keeps everything at death (no survivor benefit). It carries the most risk to the annuitant - die early and the rest is forfeited.

Worked Numeric: Comparing Payout Options

A $200,000 SPIA can be settled several ways for a 65-year-old. Approximate monthly payouts illustrate the trade-off:

• Life Only: $1,150/month - highest, but $0 to heirs if she dies in month 13.
• Life with 10-Year Certain: $1,060/month - if she dies in year 3, the beneficiary still collects for 7 more years.
• Joint & 100% Survivor (with spouse): $960/month - lowest, but income continues at full amount to the surviving spouse.

The more lives or guarantees the insurer must cover, the smaller each check. Exam tip: if a question asks which option "maximizes income to the annuitant," the answer is Life Only (straight life); if it asks which "guarantees income to a surviving spouse," the answer is Joint & Survivor.

Surrender Charges and Free-Look

Deferred fixed annuities impose surrender charges if the owner withdraws beyond the free-withdrawal corridor (often 10%/year) during the surrender period. A typical schedule declines yearly:

• Year 1: 7% - Year 2: 6% - Year 3: 5% ... Year 7: 1% - Year 8+: 0%.

Most states also require a free-look period (commonly 10-30 days, often longer for replacements and senior buyers) during which the owner can return the contract for a full refund. A withdrawal before age 59 1/2 triggers a 10% IRS premature-distribution penalty on the taxable portion, on top of ordinary income tax.

Many contracts soften the surrender charge with a free-withdrawal provision (often up to 10% of value per year penalty-free) and waive charges entirely on certain triggering events - typically the owner's death, terminal illness, or confinement to a nursing home. Exam questions frequently test the interaction of three numbers at once: the surrender charge percentage for the contract year, whether the withdrawal stays inside the free corridor, and whether the owner is under 59 1/2. A complete answer must account for the surrender charge, the ordinary income tax on gain, AND the 10% penalty where all three apply.