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?
The annuitant bears investment risk but is protected from inflation
The insurer bears investment risk while the annuitant bears purchasing-power (inflation) risk
Both investment and inflation risk are borne by the insurer
Both investment and inflation risk are borne by the annuitant
An annuitant wants the largest possible monthly income and has no dependents to protect. Which payout option fits?
Joint and survivor
Life with 20-year period certain
Life only (straight life)
Installment refund
Sections you finish are checked off in the contents.