6.2 Fixed and Immediate Annuities

Two Classification Axes

Annuities are classified on two independent axes the exam loves to combine:

1. When income begins — immediate vs. deferred.
2. How premiums are paid — single premium vs. periodic (flexible or level) premium.

A key logical rule: an immediate annuity must be funded with a single premium. You cannot pay for income over time while income is already being paid out, so there is no periodic-premium immediate annuity. Periodic premiums only make sense during a deferral (accumulation) period, which immediate annuities lack.

Immediate Annuities (SPIA)

An immediate annuity is purchased with a lump sum and begins paying income within one payment interval — within 12 months, and commonly within 30 days. It has essentially no accumulation phase; money goes straight into the payout (annuitization) phase. SPIAs are typically funded at retirement with an IRA rollover, an inheritance, a lawsuit settlement, or the cash value of a maturing life policy, to manufacture a guaranteed paycheck for life.

Fixed Annuities

In a fixed annuity the insurer bears the investment risk and guarantees both a minimum interest rate during accumulation and a fixed, level dollar payout during the payout phase. The insurer credits a current rate at or above the contractual guaranteed minimum, and backs the contract through its general account.

Because fixed annuities pay level dollars, the major drawback is purchasing-power (inflation) risk: a $1,000 monthly check buys less each year. That risk shifts to the owner even though the insurer carries the market risk. A fixed annuity is not a security, so only a life insurance license is required to sell it, and no prospectus is delivered.

Worked Numeric: Income from a SPIA

Income on a fixed immediate annuity depends on the premium, the annuitant's age and gender (life expectancy), the assumed interest rate, and the payout option chosen. A simplified illustration:

• Premium: $200,000
• Annuity payout (life-only) factor at age 65: $6.20 per $1,000 per month
• Monthly income = ($200,000 / $1,000) x $6.20 = $1,240 per month

The same $200,000 bought at age 70 produces a higher monthly figure, because a shorter remaining life expectancy concentrates the payout into fewer expected years. Conversely, adding a guarantee (period certain or refund feature) lowers the monthly income, because the insurer takes on a longer or more certain obligation.

Drivers of the Payment Amount

Memorize the headline rule: older annuitant equals higher payment; more guarantees equals lower payment. Life-only (straight life) therefore pays the most of any option because it carries no guarantee beyond the annuitant's life.

Market Value Adjustment and Surrender

Many single-premium deferred and fixed contracts carry a Market Value Adjustment (MVA): if the owner surrenders early, the surrender value is adjusted up or down based on the change in interest rates since purchase. When rates have risen since issue, the MVA reduces the surrender value; when rates have fallen, the MVA can increase it. The MVA protects the insurer's bond portfolio from being liquidated at a loss to fund an early surrender, and it applies on top of any declining surrender-charge schedule.

Worked Numeric: Surrender Charge

Suppose an owner deposits $50,000 into an SPDA and surrenders in year 2, when the surrender-charge schedule reads 7%, 6%, 5%, 4%, 3%, 2%, 1%, 0%:

• Year 2 charge rate = 6%
• Surrender charge = $50,000 x 0.06 = $3,000
• Owner receives accumulated value minus the $3,000 charge (and minus or plus any MVA)

The declining schedule rewards patience: waiting until year 8 eliminates the charge entirely. Note that surrender charges are an insurer recovery of acquisition costs, distinct from the 10% IRS premature-distribution penalty that applies to taxable gains withdrawn before age 59½. A single early surrender can therefore trigger both a contractual surrender charge and a federal tax penalty.

Why Impaired Health Helps an Annuity Buyer

Reinforce the underwriting reversal with a payout lens: because a fixed immediate annuity's monthly check rises as life expectancy shortens, an applicant with a serious health condition can sometimes obtain a medically underwritten (impaired-risk) SPIA that pays more per month than a healthy applicant of the same age receives.

This is the opposite of life-insurance underwriting, where poor health raises the premium or declines coverage. Examiners pair this with the inflation point: the higher monthly figure is still level dollars, so the impaired annuitant who lives longer than expected still faces purchasing-power erosion. Match the fact pattern carefully — health helps the annuity payout but hurts the life-insurance premium.