6.2 Fixed and Immediate Annuities

Fixed Annuities

A fixed annuity guarantees a minimum interest rate and a fixed dollar payment during payout. The insurer - not the owner - bears all investment risk. Premiums go into the insurer's general account, which is invested conservatively in bonds and mortgages. Because the insurer guarantees the result, fixed annuities are not securities and an agent needs only a life insurance license to sell them (no FINRA registration).

Guaranteed vs. Current Rate

Fixed annuities credit two rates:

• Guaranteed minimum rate - the floor the insurer can never pay below (for example, 1%-3%).
• Current (excess) rate - a higher, declared rate the insurer may pay when its investments perform well. The current rate can change, but it can never fall below the guaranteed minimum.

The Inflation Trade-off

The great weakness of a fixed annuity is purchasing-power (inflation) risk. A $1,500 monthly payment looks stable, but after 20 years of inflation it buys far less. This is the standard tested disadvantage and the reason variable and indexed products exist. A MYGA (Multi-Year Guarantee Annuity) is a fixed annuity that locks the same declared rate for the full guarantee period (such as five years), behaving much like a bank CD but with tax deferral.

Immediate Annuities (SPIA)

A Single Premium Immediate Annuity (SPIA) is funded with one lump-sum premium, and income begins almost at once - by definition within one year of purchase (commonly the first month after the deposit). There is essentially no accumulation phase; the contract goes straight to payout. SPIAs are ideal for someone who has just received a lump sum (an inheritance, a 401(k) rollover, a property sale) and needs income right away.

Immediate vs. Deferred Timing

The defining test point is when income begins:

• Immediate annuity - income starts within 12 months; always funded by a single premium.
• Deferred annuity - income starts more than 12 months out, after an accumulation period.

Worked Example - Reading a SPIA Payout

A 65-year-old deposits $300,000 into a SPIA that pays a life-only rate of $5.80 per $1,000 of premium per month.

• Monthly income = ($300,000 / $1,000) x $5.80 = $1,740 per month.
• Because the contract is fixed, that $1,740 never changes - so over time inflation erodes its value.

If the same person instead chose a smaller, inflation-adjusted payout, the first check would be lower but would rise each year. The exam wants you to recognize that a fixed SPIA trades a higher starting check for zero inflation protection.

Fixed Annuity Income Is Level

Once a fixed annuity is annuitized, each payment is the same dollar amount for the entire payout period. This is what makes a fixed annuity attractive to conservative buyers - the income is predictable and the principal is never exposed to market loss. The insurer can deliver this certainty because it has guaranteed the rate and absorbed the investment risk inside its general account.

Why Level Income Is a Double-Edged Sword

The certainty that protects against market loss is the same feature that creates inflation risk. A retiree receiving $1,740 a month today will still receive exactly $1,740 a month in 20 years, but at 3% annual inflation that check buys roughly half as much. The exam frames this as the central limitation of fixed products and the reason variable and indexed annuities were created.

Suitability Considerations

State suitability rules require an agent to gather and document the client's financial situation before recommending an annuity. Key factors include:

• Age and time horizon - surrender periods can lock up money for years.
• Liquidity needs - an emergency fund should exist outside the annuity.
• Source of funds - replacing one annuity with another (a 1035 exchange) must benefit the client, not just generate a commission.
• Risk tolerance - a fixed annuity suits a buyer unwilling to risk principal.

MYGA vs. Bank CD

A MYGA guarantees a single declared rate for the entire term, so it competes directly with bank certificates of deposit. The key difference: the MYGA grows tax-deferred until withdrawal, while CD interest is taxed each year. The trade-off is the MYGA's surrender charge and the 10% IRS penalty on gains taken before age 59 1/2.

Fixed Annuities — Guarantees and the General Account

A fixed annuity credits a guaranteed minimum interest rate plus any current excess rate, with principal held in the insurer's general account. The insurer bears the investment risk, and payouts are level and predictable. Because there is no investment risk to the buyer, a fixed annuity producer needs only a life license — not a securities registration.

Immediate vs. Deferred (by Payout Timing)

Worked Example: A retiree rolls $250,000 into a SPIA with a life-only payout and begins receiving monthly checks 30 days later. Because payments start within a year, it is immediate; because it is funded once, it is single premium. A life-only option pays the highest monthly amount but stops at death with nothing to heirs.

Interest Rate Mechanics

The guaranteed rate is the floor written into the contract (e.g., 1-3%); the current rate is what the insurer actually credits and can change periodically but never below the floor. Surrender charges usually decline over a set schedule (e.g., 7% in year one grading to 0%), and many contracts allow a 10% free withdrawal each year without charge.