9.3 Immediate vs. Deferred and Single vs. Flexible Premium
Key Takeaways
- An immediate annuity (SPIA) is funded with a single premium and begins income within one payment period (usually 12 months).
- A deferred annuity delays the income start date, allowing a tax-deferred accumulation phase before payout.
- Single Premium (SPDA/SPIA) is funded with one lump sum; flexible premium (FPDA) allows varying periodic deposits.
- A flexible premium annuity must be deferred, because periodic premiums require an accumulation period before income can begin.
- Deferred annuities offer a death benefit during accumulation (typically the greater of premiums paid or current value).
Classifying Annuities by Income Start Date
Aside from the investment classification (fixed/variable/indexed), annuities are classified by when income payments begin and by how premiums are paid. These two dimensions combine into the common product names tested on the exam.
Immediate vs. Deferred
- An immediate annuity begins paying income within one payment interval of purchase - usually within 12 months (or as soon as one month for monthly payments). It must be funded with a single premium, producing the product called a Single Premium Immediate Annuity (SPIA).
- A deferred annuity delays the start of income to a future date, allowing premiums to grow during an accumulation phase before annuitization.
Exam Tip: "Immediate" means income starts within one payment period; it must be a single-premium product.
Classifying Annuities by Premium Payment
- A single premium annuity is funded with one lump-sum deposit. There are no further premiums.
- A flexible premium annuity allows the owner to pay varying amounts at varying times (subject to contract minimums and maximums). Because payments come in over time, the contract must accumulate before income can begin.
The Valid Combinations
| Product | Premium | Income start | Valid? |
|---|---|---|---|
| SPIA - Single Premium Immediate Annuity | One lump sum | Within ~1 period | Yes |
| SPDA - Single Premium Deferred Annuity | One lump sum | Future date | Yes |
| FPDA - Flexible Premium Deferred Annuity | Periodic | Future date | Yes |
| Flexible Premium Immediate Annuity | Periodic | Immediate | Impossible |
Why a Flexible Premium Immediate Annuity Cannot Exist
Income cannot begin immediately if premiums are still being collected over time - there is no accumulated value yet to annuitize. Therefore a flexible premium annuity is always deferred.
Exam Tip: Flexible premium = ALWAYS deferred. Immediate = ALWAYS single premium. These two rules are heavily tested.
The Death Benefit During Deferral
A distinguishing feature of a deferred annuity is the death benefit available before annuitization. If the annuitant or owner dies during the accumulation phase, the beneficiary generally receives the greater of total premiums paid or the current contract value.
Worked Example
An owner deposits $50,000 into an SPDA. After several years the contract value has declined to $48,000 (in an indexed/variable context) or grown to $62,000.
| Scenario | Premiums paid | Current value | Death benefit paid |
|---|---|---|---|
| Value grew | $50,000 | $62,000 | $62,000 |
| Value declined | $50,000 | $48,000 | $50,000 (return of premium) |
This guarantee protects the beneficiary from market losses during accumulation. Note: a SPIA, having no accumulation phase, instead protects beneficiaries only through the chosen payout option (e.g., period certain or refund), covered in the next section.
Exam Tip: During deferral, the death benefit is the GREATER of premiums paid or account value - never less than what was contributed.
Surrender Period and Liquidity in Deferred Annuities
Deferred annuities impose a surrender charge period during which early withdrawals above the free corridor incur a declining penalty. A typical schedule starts high and steps down to zero.
| Contract year | Surrender charge |
|---|---|
| 1 | 7% |
| 2 | 6% |
| 3 | 5% |
| 4 | 4% |
| 5 | 3% |
| 6 | 2% |
| 7 | 1% |
| 8+ | 0% |
Most contracts also permit a free withdrawal of about 10% of value annually without a surrender charge. If an owner with a $100,000 SPDA in year 2 withdraws $30,000, the first $10,000 is penalty-free, and the remaining $20,000 incurs the 6% charge ($1,200).
Exam Tip: Surrender charges are an insurer's protection against early lapse and are the chief liquidity drawback of deferred annuities.
The 1035 Exchange
Internal Revenue Code Section 1035 lets an owner exchange one annuity for another (or a life policy for an annuity) without triggering current income tax on the gain. The cost basis and gain carry over to the new contract.
Permitted (tax-free) 1035 directions:
- Life insurance to life insurance
- Life insurance to annuity
- Annuity to annuity
- Life or annuity to qualified long-term care
NOT permitted: an annuity to life insurance (you cannot move tax-deferred annuity gains into a tax-free death benefit). A 1035 exchange does not restart the IRS clock but usually starts a new surrender-charge schedule, so producers must confirm the exchange is suitable - this is a frequent improper-replacement issue.
Exam Tip: Annuity-to-life is the one 1035 direction that is NOT allowed.
Putting the Classifications Together
A single annuity is described by all three dimensions at once. For example, a producer might sell a flexible premium deferred fixed annuity - meaning the client pays varying premiums (flexible), income starts later (deferred), and the insurer guarantees principal and a minimum rate (fixed).
- When does income start? Immediate or deferred.
- How are premiums paid? Single or flexible.
- How is value invested? Fixed, variable, or indexed.
Suitability Cross-Reference
| Client need | Likely structure |
|---|---|
| Just sold a house, wants income now | SPIA (single premium, immediate) |
| Lump sum to grow safely for later income | SPDA fixed |
| Wants to save monthly toward retirement | FPDA |
| Comfortable with market risk for growth | Deferred variable |
Exam Tip: A question describing periodic deposits toward future retirement income points to a Flexible Premium Deferred Annuity (FPDA).
A 62-year-old just received a $250,000 lump sum and wants guaranteed monthly income starting next month for the rest of her life. Which annuity structure fits BEST?
An annuitant dies during the accumulation phase of a deferred annuity. Total premiums paid were $80,000 and the current account value has fallen to $74,000. What does the beneficiary typically receive?