6.3 Deferred and Indexed Annuities

Deferred Annuity Mechanics

A deferred annuity postpones income to a future date, allowing the contract value to grow tax-deferred during accumulation. It can be funded by a single premium (SPDA) or flexible premiums (FPDA). During accumulation the owner can surrender the contract or take partial withdrawals, subject to surrender charges and possible tax penalties; at the chosen maturity date the owner annuitizes into one of the standard payout options.

Key contractual values to distinguish:

• Accumulation value - total premiums plus credited interest.
• Cash (surrender) value - accumulation value minus any surrender charge.
• Death benefit during accumulation - generally the greater of accumulation value or premiums paid; if the annuitant dies before annuitization, the beneficiary receives this amount, avoiding probate.

Surrender Charges and the Bailout Provision

Deferred annuities impose a declining surrender charge to discourage early withdrawal, commonly a schedule such as 7% in year one, decreasing one point per year to 0% after seven years. Most contracts allow a free-withdrawal corridor - often 10% of value per year - without charge.

A bailout provision lets the owner surrender without penalty if the credited current rate falls more than a stated amount (e.g., 1%) below the rate at issue. Worked example: a $50,000 SPDA surrendered in year two with a 6% charge on the amount above the 10% free corridor yields a charge of 6% x ($50,000 - $5,000) = $2,700, so the owner nets $47,300 before tax.

Equity-Indexed (Fixed Indexed) Annuities

A fixed indexed annuity (FIA), also called an equity-indexed annuity, is legally a fixed annuity. It credits interest linked to an external index such as the S&P 500 but still guarantees a minimum return, so principal is protected. Because it is a general-account product with a floor, most states classify it as fixed (often no securities license required), though suitability scrutiny is high.

The defining feature is the combination of upside participation with a downside floor: in a down market the index credit is zero (or the small guaranteed minimum), never negative. The trade-off is that the owner does not capture the full index gain - several limiting features reduce it.

Indexed Crediting Features (Exam Vocabulary)

Worked example: the index rises 10%. With an 80% participation rate the gross is 8%; if a 6% cap also applies, the credit is capped at 6%. If instead a 2% spread applies to the 10% gain, the credit is 8%. Candidates must apply participation first, then the cap, and recognize that the floor protects principal in losing years.

Common Traps

• An indexed annuity is not a variable annuity; principal is protected and the contract is a fixed-annuity chassis.
• The owner is not invested in the index - it is only a measuring benchmark for crediting interest.
• Caps, participation rates, and spreads are the reason actual credits trail raw index gains - this is the most-tested concept.
• Surrender periods on FIAs are often long (7-10 years), so suitability for older buyers is a regulatory hot spot.