6.2 Fixed and Immediate Annuities
Key Takeaways
- Fixed annuities guarantee a minimum interest rate and protect principal; the insurer bears investment risk and holds funds in its general account.
- A SPIA (single premium immediate annuity) begins income within one year of purchase — there is essentially no accumulation phase.
- MYGAs lock a guaranteed rate for a set term (3–10 years), functioning like a tax-deferred CD.
- Surrender charge schedules typically decline year by year and reach zero after 5–10 years.
- Fixed annuities suit risk-averse savers near retirement but may lag inflation.
Fixed Annuity Mechanics
In a fixed annuity the insurer guarantees a minimum interest rate and assumes all investment risk. Premium goes into the insurer's general account, which holds conservative assets (bonds, mortgages, real estate).
| Rate type | Description | Can it fall? |
|---|---|---|
| Guaranteed minimum | Floor the insurer will always credit (often 1–3%) | No — never below this floor |
| Current / declared | Actual rate now being credited; usually above the floor | Yes — but not below the floor |
| Bonus | First-year teaser added to attract buyers | N/A |
Exam trap: A bonus rate usually comes with a longer surrender period or extra fees. Evaluate the whole contract, not the headline rate.
Classification by Premium Payment
The exam tests how premium timing combines with when income starts.
| Product | Premium | Income begins | Typical use |
|---|---|---|---|
| SPIA (single premium immediate) | One lump sum | Within 1 year | Income needed now |
| SPDA (single premium deferred) | One lump sum | Future date | Tax-deferred growth of a windfall |
| FPDA (flexible premium deferred) | Ongoing/variable | Future date | Building retirement savings over time |
Key distinction: an immediate annuity has essentially no accumulation phase — the first payment must occur within 12 months. Deferred annuities postpone income, allowing tax-deferred growth first.
MYGA worked example
A multi-year guarantee annuity (MYGA) locks a rate for a fixed term, like a CD but tax-deferred.
- Deposit $100,000 in a 5-year MYGA at a guaranteed 5.00% compounded annually.
- After 5 years: 100,000 × (1.05)^5 = $127,628.
- Because growth is tax-deferred, no tax is due until withdrawal — unlike a CD whose interest is taxed each year.
Surrender Charges and Free Withdrawal
Deferred fixed annuities impose surrender charges on amounts withdrawn above the free-withdrawal allowance during the surrender period. The schedule declines over time.
| Year | Surrender charge |
|---|---|
| 1 | 7% |
| 2 | 6% |
| 3 | 5% |
| 4 | 4% |
| 5 | 3% |
| 6 | 2% |
| 7 | 1% |
| 8+ | 0% |
Free-withdrawal provisions commonly include:
- Up to 10% of account value per year with no charge.
- Waivers for death, disability, or nursing-home confinement.
Worked surrender example
Account value $50,000, year 2 (6% charge), free withdrawal 10%.
- Free amount: 10% × 50,000 = $5,000 (no charge).
- Owner withdraws $15,000. Excess over free = 15,000 − 5,000 = $10,000.
- Surrender charge = 6% × 10,000 = $600.
- Net to owner = 15,000 − 600 = $14,400 (before any 10% pre-59½ tax penalty on gains).
SPIA Income Illustration
A SPIA converts a lump sum into immediate guaranteed income.
- A 70-year-old deposits $200,000 in a straight-life SPIA quoting roughly 7% of premium annually.
- Guaranteed income ≈ $14,000/year ($1,167/month) for life.
- Older issue age = higher payout, because remaining life expectancy is shorter and mortality credits are larger.
Trade-off: under a straight-life option the income stops at death and nothing passes to heirs. A period-certain or refund option lowers the payment but protects beneficiaries.
Bailout Provisions and the Minimum Guarantee
Fixed annuities credit a current declared rate but guarantee a minimum rate (often 1-3%) below which crediting cannot fall, protecting principal-conscious buyers. Some contracts include a bailout provision: if the renewal rate drops below a stated bailout rate, the owner may surrender without surrender charges. This addresses the risk that an insurer credits a high teaser rate, then drops it after the first year.
Because the insurer guarantees principal and a minimum return, the insurer bears the investment risk in a fixed annuity — the opposite of a variable annuity. That risk allocation is why fixed annuities require only a life license, not a securities registration, and why they are suitable for conservative, principal-protection-focused clients.
Worked Surrender Charge Example
A deferred fixed annuity has a 7-year declining surrender charge starting at 7% and dropping one point per year, plus a 10% annual free-withdrawal privilege. The owner has $100,000 and, in year 2 (6% charge), withdraws $25,000.
The first $10,000 (10% free withdrawal) escapes any charge. The remaining $15,000 is subject to the 6% year-2 surrender charge: $15,000 × 6% = $900. Net cash to the owner is $25,000 − $900 = $24,100. After the surrender-charge period ends, the full account is available charge-free. Examiners use this structure to test whether you apply the free-withdrawal allowance before calculating the charge on the excess.
Immediate vs. Deferred and Premium Timing
Fixed annuities are classified two ways the exam cross-tabulates. By when income starts: an immediate annuity (SPIA) begins payments within about one year of purchase; a deferred annuity delays income to a future date. By how premium is paid: single premium (one lump sum) or flexible/periodic premium (a series of deposits).
The only logically impossible combination is a flexible-premium immediate annuity — you cannot begin immediate lifetime payouts while still making periodic deposits. So an immediate annuity is always single premium, while deferred annuities may be single or flexible premium. Recognizing that one impossible pairing is a frequent exam trap, because a tempting wrong answer often lists "flexible premium immediate annuity" as if it existed.
An annuity funded with a single lump sum that begins paying income within one year is BEST described as a:
An owner withdraws $15,000 from a $50,000 fixed annuity in year 2 (6% surrender charge, 10% free withdrawal). What surrender charge applies?