9.3 Immediate vs. Deferred and Single vs. Flexible Premium
Key Takeaways
- Classification by when income begins: an immediate annuity starts payments within about one year; a deferred annuity delays income to a future date.
- Classification by how premium is paid: single premium is one lump sum; flexible premium allows multiple, varying contributions over time.
- A SPIA (single premium immediate annuity) is funded with a lump sum and begins income almost at once; it has no real accumulation phase.
- Only deferred annuities have an accumulation phase, so only they can be funded by flexible premiums; an immediate annuity must be single premium.
- Deferred annuities carry surrender charges that decline over a surrender period, plus a free withdrawal corridor (often 10% per year).
Two Independent Classification Axes
Annuities are sorted along two separate questions. Keep them distinct on the exam.
- When does income begin? Immediate vs. deferred.
- How is premium paid? Single premium vs. flexible (periodic) premium.
When Income Begins
- Immediate annuity: income payments begin within roughly one payment interval (about 12 months) of purchase. There is essentially no accumulation phase.
- Deferred annuity: income is postponed to a future date months or decades away allowing an accumulation phase during which value grows tax-deferred.
How Premium Is Paid
- Single premium: funded with one lump-sum payment.
- Flexible premium: funded with multiple contributions of varying amounts over time, subject to contract minimums.
The Valid Combinations
The two axes combine, but not all four pairings are possible. This is a favorite test point.
| Combination | Possible? | Reason |
|---|---|---|
| Single Premium Immediate (SPIA) | Yes | Lump sum, income starts at once |
| Single Premium Deferred (SPDA) | Yes | Lump sum now, income later; value accumulates |
| Flexible Premium Deferred (FPDA) | Yes | Periodic deposits build value, income later |
| Flexible Premium Immediate | No | Income cannot begin immediately if premiums are still being paid in over time |
Key rule: Flexible premium requires a deferred annuity. Because flexible contributions need time to accumulate, only deferred contracts can accept them. An immediate annuity must therefore be single premium.
The SPIA in Practice
A single premium immediate annuity (SPIA) is the classic income tool: a retiree hands the insurer a lump sum say, $250,000 and the insurer begins level monthly income within 30 days to a year. Because income begins right away, there is no accumulation phase and no surrender value to grow. SPIAs are popular for pension-like income and for funding a structured settlement.
A single premium deferred annuity (SPDA) instead takes the lump sum and lets it compound tax-deferred until a later annuitization or withdrawal a common rollover vehicle.
Surrender Charges and Liquidity
Deferred annuities recover the insurer's acquisition costs through a surrender charge a penalty for early withdrawal that declines over a surrender period, commonly 7 to 10 years. A typical schedule:
| Contract year | Surrender charge |
|---|---|
| 1 | 7% |
| 2 | 6% |
| 3 | 5% |
| 4 | 4% |
| 5 | 3% |
| 6 | 2% |
| 7 | 1% |
| 8+ | 0% |
Most contracts allow a free withdrawal of about 10% of value per year without surrender charge. These charges are separate from the IRS 10% premature distribution penalty that applies to taxable gains withdrawn before age 59 . An immediate annuity has no surrender schedule because there is no cash value to surrender once income has begun.
A client wants to make varying contributions to an annuity over the next 15 years and begin income at retirement. Which classification fits?
A retiree pays $300,000 in a lump sum and the insurer begins monthly income the next month. What type of annuity is this, and does it have a surrender period?
The Annuity Period and Free-Look
Once a deferred annuity moves from accumulation into the annuity (payout) phase, the contract is generally irrevocable for the payout option chosen. Before that point the owner can surrender, exchange, or change beneficiaries. The exam wants you to recognize that the accumulation phase is flexible and the annuitization phase is locked.
Many states, including those that adopt the NAIC model, require a free-look period (commonly 10 to 30 days) during which the buyer may cancel a new annuity for a full refund. For a replacement annuity the free-look is often extended. During the free-look on a variable annuity, premium may have to be held in a fixed/guaranteed option in some states so the buyer is not exposed to market loss before the decision window closes.
Worked Numeric: Surrender Charge and Free Withdrawal
A deferred annuity has a $100,000 value, a year-3 surrender charge of 5%, and a 10% annual free-withdrawal corridor. The owner withdraws $30,000 in year 3.
- Free amount: 10% of $100,000 = $10,000 (no charge).
- Amount subject to charge: $30,000 - $10,000 = $20,000.
- Surrender charge: 5% of $20,000 = $1,000.
Separately, if the owner is under age 59 1/2, the taxable gain portion also faces the IRS 10% premature-distribution penalty. Surrender charges (insurer cost recovery) and the IRS penalty (tax rule) are independent, and a question may test both at once.
A deferred annuity worth $200,000 allows a 10% annual free withdrawal and has a current 4% surrender charge. The owner withdraws $50,000. What surrender charge applies?