6.2 Fixed and Immediate Annuities
Key Takeaways
- Fixed annuities credit a guaranteed minimum rate (with a higher current rate) from the general account; no securities license needed.
- The fixed annuity's key weakness is purchasing-power (inflation) risk because payments are level.
- A SPIA is single-premium and begins income within one payment interval; deferred annuities delay payout for tax-deferred growth.
- Income equals (deposit / 1,000) x the per-$1,000 payout factor; younger/female annuitants and added guarantees lower the factor.
- Life-only pays the most; adding a period certain, refund, or second life always reduces the monthly amount.
The Fixed Annuity Guarantee
A fixed annuity credits a guaranteed minimum rate of interest and pays a guaranteed, level dollar income during payout. Premiums go into the insurer's general account, where they are invested conservatively in bonds and mortgages. Because the insurer - not the owner - bears the investment risk, the producer needs only a life license to sell a fixed annuity; no securities registration is required.
The insurer typically credits two rates: a guaranteed minimum rate stated in the contract (e.g., 1-3%) and a higher current rate declared periodically based on portfolio performance. The current rate can never drop below the guaranteed floor. This floor protects principal and is the defining safety feature of a fixed annuity.
Purchasing-Power Risk
The fixed annuity's great weakness is inflation. Because payments are level, a $1,000 monthly income buys less each year as prices rise. This purchasing-power risk is the classic disadvantage tested on the exam, and it is precisely the risk a variable annuity attempts to solve. Candidates should be able to state: a fixed annuity transfers investment risk to the insurer but leaves inflation risk with the annuitant; a variable annuity does the reverse.
Immediate vs. Deferred Timing
A single premium immediate annuity (SPIA) is funded with one lump sum and begins income within one payment interval - the first check arrives no later than one year (often one month) after purchase. There is essentially no accumulation period. SPIAs are popular for converting a 401(k) rollover or lawsuit settlement into guaranteed lifetime income.
A deferred annuity delays the payout to a future date, allowing tax-deferred accumulation first. The same fixed-rate mechanics apply, but timing differs. Memory aid: immediate means income starts now; deferred means income starts later. A SPIA cannot be flexible-premium because it must be fully funded before income begins.
Worked Example: SPIA Income
Suppose a 65-year-old man deposits $250,000 in a SPIA and the insurer's life-only rate for his age is $5.60 per $1,000 per month. His monthly income is:
($250,000 / $1,000) x $5.60 = 250 x $5.60 = $1,400 per month.
If he instead chooses a life-with-10-year-period-certain option, the per-$1,000 factor drops (say $5.20), reducing income to 250 x $5.20 = $1,300 per month - the trade-off for guaranteeing a minimum number of payments to a beneficiary. Note that a younger or female annuitant, with longer life expectancy, receives a smaller monthly amount from the same deposit.
Payout (Annuity) Options
The option chosen at annuitization fixes how long income lasts and what survivors receive:
| Option | What it pays | Who it suits |
|---|---|---|
| Life only (straight/pure life) | Highest income, ends at annuitant's death, nothing to heirs | Maximum income, no dependents |
| Life with period certain | Lifetime income; if death is early, beneficiary collects the rest of the guaranteed period (e.g., 10 yrs) | Wants a heir safety net |
| Life with refund (cash/installment) | Lifetime income; guarantees total payout at least equals premium | Wants principal protection |
| Joint and survivor (e.g., J&S 2/3) | Pays while either of two annuitants lives | Married couples |
| Period certain only | Pays for a set term regardless of life | Bridge income to another source |
Trap: life-only pays the most because the insurer keeps everything at death; adding any guarantee lowers the monthly amount. Joint-and-survivor pays less than single life because two lives must be covered.
Which statement correctly describes the risk allocation of a fixed annuity?
An annuitant wants the largest possible monthly income and has no dependents to protect. Which payout option fits?