6.2 Fixed and Immediate Annuities

A fixed annuity guarantees both a fixed rate of interest during accumulation and fixed, level payments during the payout phase. The insurer assumes all investment risk because premiums are deposited in the insurer's general account, which holds conservative investments such as bonds and mortgages. Because the insurer bears the risk, no securities license is required to sell a traditional fixed annuity - only a life insurance license.

Interest Rate Guarantees

Fixed annuities carry two rates:

• The guaranteed minimum rate - the floor the insurer will never pay below (e.g., 1% or 3%).
• The current (excess) rate - the higher rate the insurer actually credits based on portfolio performance, declared periodically.

The owner is protected by the floor even if market rates fall, but enjoys upside when the insurer credits the current rate.

Purchasing Power Risk

The chief disadvantage of fixed annuities is purchasing power risk (inflation risk). A level $1,000 monthly payment buys less each year as prices rise. Over a 25-year retirement, 3% annual inflation cuts real purchasing power by roughly half. This is the trade-off for guaranteed safety.

Multi-Year Guaranteed Annuity (MYGA)

A MYGA locks in a single guaranteed rate for a set term (e.g., 3% for 5 years), functioning much like a bank CD but with tax-deferred growth. At the end of the term the owner may renew, annuitize, surrender, or roll to another contract via a tax-free 1035 exchange.

Immediate vs. Deferred (by Payout Timing)

Annuities are also classified by when income payments begin.

A SPIA can never be funded with periodic premiums - by definition the income starts almost immediately, so there is no accumulation period to spread premiums over. The exam tests this: an immediate annuity is always a single-premium contract.

Worked Example: SPIA Income

A retiree deposits $250,000 into a SPIA at age 70. Income starts one month later. Suppose the insurer's straight-life factor at age 70 yields $6.80 of monthly income per $1,000 of premium.

Monthly income = ($250,000 / $1,000) x $6.80 = 250 x $6.80 = $1,700 per month.

This income is guaranteed for life. Note that under a straight-life option, if the retiree dies after only two payments, the insurer keeps the remaining principal - there is no refund to a beneficiary. That liquidity-versus-income trade-off is the core SPIA decision.

Single vs. Flexible Premium

Deferred annuities can be funded two ways:

• Single Premium Deferred Annuity (SPDA) - one lump sum, then growth until a future payout.
• Flexible Premium Deferred Annuity (FPDA) - periodic, variable contributions (within limits) building the account over time, common for retirement savers.

Common Trap

Do not confuse the two classification systems. One classifies by how premiums are paid (single vs. flexible); the other classifies by when income begins (immediate vs. deferred). An immediate annuity must be single premium, but a single-premium annuity is not necessarily immediate - it can be a SPDA.

Market-Value Adjustment (MVA)

Some fixed and MYGA contracts include a market-value adjustment. If the owner surrenders early, the cash value is adjusted up or down based on how interest rates have moved since purchase. When rates have risen, the adjustment reduces the surrender value (the insurer must sell bonds at a loss); when rates have fallen, it can increase the value. The MVA shifts interest-rate risk to the owner during the surrender window in exchange for a higher crediting rate.

The Annuitization Decision

When an immediate income contract is purchased, the owner trades liquidity for income. Under a straight life SPIA the income is highest because no death guarantee exists, but the principal is forfeited at death. Adding a period certain or refund feature lowers the monthly payment but protects beneficiaries. The choice depends on whether the client most fears outliving their money or losing principal to an early death.

Worked Example: Refund Trade-Off

Return to the $250,000 SPIA at age 70 paying $1,700 per month on a straight-life basis. Suppose adding a 10-year period certain reduces the factor to $6.40 per $1,000.

New monthly income = 250 x $6.40 = $1,600 per month, a $100 reduction. In exchange, if the annuitant dies in year 4, the beneficiary continues receiving $1,600 monthly for the remaining 6 years of the certain period. The $100 monthly reduction is the cost of guaranteeing at least 120 payments. This liquidity-versus-income calculus is a favorite exam scenario.

Reading the Payout-Guarantee Trade-off

Fixed and immediate annuity questions almost always test the trade-off between income size and guarantees. A straight life (life-only) option pays the largest periodic check because the insurer keeps whatever is left when the annuitant dies, but it leaves nothing to heirs. Adding a guarantee — a period certain (payments for at least a set number of years) or a refund feature (cash or installment refund of the unrecovered premium) — protects against the annuitant dying early, but every such guarantee reduces the monthly payment because the insurer must reserve for the possibility of paying a beneficiary.

The distinction between immediate and deferred is the other anchor. A single-premium immediate annuity (SPIA) is funded with one lump sum and begins income within about a year, ideal for someone who already has a sum to convert into lifetime income, such as a retiree or a structured-settlement recipient. A deferred annuity accumulates first and annuitizes later.

Worked point: If a life-only option pays $1,100 per month and a life-with-10-year-certain option on the same premium pays $1,000, the $100 monthly reduction is the price of guaranteeing at least 120 payments to a beneficiary. Expect a scenario that asks you to identify why the guaranteed option pays less — the answer is the cost of the death-protection guarantee, not a fee or a lower interest rate.