9.3 Immediate vs. Deferred and Single vs. Flexible Premium

Two Independent Classifications

Annuities are described by when income begins and by how premium is paid. These are separate axes, and the exam tests whether you can combine them correctly.

By payout timing:

• Immediate annuity: income begins within roughly one payment interval (about 12 months) of purchase. There is essentially no accumulation phase.
• Deferred annuity: income begins at a future date, after an accumulation phase during which value grows tax-deferred.

By premium structure:

• Single premium: funded with one lump sum.
• Flexible premium: funded with periodic, varying deposits over time.

Think of timing as the answer to "when do I get paid?" and premium structure as the answer to "how do I pay in?" Mixing them up is the most common error on these items.

Valid and Invalid Combinations

The flexible premium immediate annuity does not exist: you cannot simultaneously be making ongoing deposits (which requires an accumulation period) and receiving immediate income from a single lump sum. Any flexible premium annuity is therefore a deferred annuity.

Exam Tip: If a question offers "flexible premium immediate annuity" as a choice, it is the wrong answer by definition. Memorize the three valid products SPIA, SPDA, FPDA and the one impossible pairing.

Immediate Annuities (SPIA)

A Single Premium Immediate Annuity converts a lump sum into income that starts almost at once. There is no surrender period in the usual sense because the contract is already paying out; many SPIAs are irrevocable once issued.

A SPIA fits a client who has a sum now and needs income now for example, a 68-year-old rolling a 401(k) lump sum into guaranteed monthly income. Because there is no accumulation, the SPIA is about distribution, not growth.

Worked example: A retiree pays $200,000 for a SPIA quoting $1,050 per month for life. Annual income is $12,600, an initial payout rate of about 6.3%. Older annuitants get higher rates because their shorter life expectancy means fewer expected payments. The same $200,000 might buy only $850 per month for a 60-year-old, whose longer life expectancy spreads the payout over more years.

Deferred Annuities (SPDA / FPDA)

Deferred annuities have a real accumulation phase and therefore additional features:

• Surrender charges during a defined period (often 5 to 10 years).
• A death benefit before annuitization typically the greater of premiums paid (less withdrawals) or current value.
• The owner's right to annuitize, withdraw, exchange (1035), or surrender.

An SPDA suits someone funding with a lump sum today for income years from now, such as a 55-year-old depositing an inheritance to grow tax-deferred until retirement. An FPDA suits a younger saver contributing periodically toward retirement, the way one might fund an IRA with monthly contributions.

A deferred annuity can later be annuitized, but it does not have to be the owner may keep it growing, take systematic withdrawals, or exchange it for another contract under Section 1035 without current tax.

Time Horizon and the Surrender Period

Matching the surrender period to the client's time horizon is central to suitability and shows up repeatedly on the exam. A deferred annuity's surrender schedule can run 5 to 10 years; if the client may need the money sooner, the charges make the contract unsuitable.

Worked example: A 60-year-old buys an SPDA with a 7-year surrender schedule (7% declining 1% per year) intending to retire at 67. The horizon and the schedule align withdrawals after year seven incur no surrender charge. By contrast, a 78-year-old likely to need funds for care within a few years should not be placed in the same contract.

Remember that an immediate annuity generally cannot be surrendered or reversed once payments begin, which is exactly why it is reserved for clients who are certain they want lifetime income now.

Surrender charges and the deferred-annuity exit

Deferred annuities carry a declining surrender-charge schedule (for example, 7% in year 1 grading to 0% after 7 years). Most contracts also permit a free withdrawal of up to 10% of the value each year without surrender charge, and many add a bailout provision letting the owner surrender penalty-free if the renewal interest rate falls below a stated trigger. These features matter for both suitability and the tax penalty analysis.

Market value adjustment

Some fixed deferred annuities include a market value adjustment (MVA): surrendering early adjusts the payout up or down based on interest-rate movement since issue. If rates have risen, the MVA reduces the surrender value; if rates have fallen, it can increase it. The MVA shifts interest-rate risk to the owner in exchange for a higher credited rate, a frequently tested fixed-annuity feature that does not make the product a variable annuity.