Classification by Premium Payment
Annuities can be classified based on how premiums are paid and when income payments begin. Understanding these classifications is essential for the licensing exam and for recommending appropriate products to clients.
Immediate vs. Deferred Annuities
The first major distinction is when income payments begin:
| Type | Income Begins | Premium Structure |
|---|---|---|
| Immediate annuity | Within one year of purchase (typically within 30 days) | Single premium only |
| Deferred annuity | At a future date chosen by owner | Single or flexible premiums |
Single Premium Immediate Annuity (SPIA)
A Single Premium Immediate Annuity (SPIA) is purchased with one lump-sum payment, and income payments begin almost immediately.
How SPIAs Work
| Feature | Description |
|---|---|
| Premium payment | One lump sum at purchase |
| Income start | Within 30 days to 1 year |
| Accumulation phase | None (immediate payout) |
| Primary purpose | Convert lump sum to immediate income |
SPIA Uses
| Use Case | Example |
|---|---|
| Retirement income | Convert 401(k) rollover to lifetime income |
| Pension replacement | Replace employer pension with guaranteed income |
| Structured settlements | Personal injury award converted to payments |
| Lottery winnings | Convert lump sum to annual payments |
SPIA Considerations
Advantages:
- Immediate guaranteed income
- No accumulation risk
- Simple product—no investment decisions
- Higher payout rates than deferred annuities
Disadvantages:
- Irrevocable—cannot access principal
- No growth potential
- Inflation erodes purchasing power (unless inflation-adjusted)
- Death early may result in loss of principal (life-only option)
Exam Tip: SPIAs are ideal for retirees who need immediate income and want to eliminate longevity risk. The tradeoff is loss of liquidity and access to the lump sum.
Single Premium Deferred Annuity (SPDA)
A Single Premium Deferred Annuity (SPDA) is purchased with one lump-sum payment, but income payments are deferred until a future date.
How SPDAs Work
| Feature | Description |
|---|---|
| Premium payment | One lump sum at purchase |
| Income start | Future date chosen by owner |
| Accumulation phase | Yes—value grows tax-deferred |
| Surrender charges | Apply during surrender period |
Types of SPDAs
| Type | How Value Grows |
|---|---|
| Fixed SPDA | Guaranteed interest rate (may adjust periodically) |
| Variable SPDA | Investment in subaccounts; value fluctuates |
| Indexed SPDA | Linked to market index with caps and floors |
SPDA Considerations
Advantages:
- Tax-deferred growth
- Control over when to annuitize
- Can take withdrawals before annuitizing
- Larger initial deposit starts compounding immediately
Disadvantages:
- Surrender charges limit liquidity
- 10% penalty on withdrawals before age 59½
- No additional contributions allowed
- May not maximize tax deferral (limited to initial deposit)
Flexible Premium Deferred Annuity (FPDA)
A Flexible Premium Deferred Annuity (FPDA) allows multiple premium payments over time, with income deferred until a future date.
How FPDAs Work
| Feature | Description |
|---|---|
| Premium payments | Multiple payments allowed over time |
| Minimum/maximum | Often have minimum contribution requirements |
| Income start | Future date chosen by owner |
| Flexibility | Can increase, decrease, or skip payments |
FPDA Payment Options
| Option | Description |
|---|---|
| Regular periodic payments | Monthly, quarterly, or annual contributions |
| Irregular payments | Contribute when able |
| Payroll deduction | Automatic contributions from paycheck |
| Lump sum additions | Add larger amounts when available |
FPDA Considerations
Advantages:
- Flexibility to contribute over time
- Suitable for those accumulating retirement savings
- Can adjust contributions based on income
- Tax-deferred growth on all contributions
Disadvantages:
- May not contribute consistently
- Lower initial balance means less compounding
- Surrender charges apply to each contribution period
- Requires ongoing commitment
Comparison of Premium Payment Types
| Feature | SPIA | SPDA | FPDA |
|---|---|---|---|
| Premium | Single lump sum | Single lump sum | Multiple payments |
| Income start | Immediate | Deferred | Deferred |
| Accumulation phase | No | Yes | Yes |
| Tax deferral | N/A (immediate payout) | Yes | Yes |
| Flexibility | Low (irrevocable) | Moderate | High |
| Best for | Immediate income need | Lump sum to invest | Building savings over time |
Key Considerations for Selection
When to Recommend Each Type
| Client Situation | Recommended Type |
|---|---|
| Has lump sum, needs income now | SPIA |
| Has lump sum, wants tax-deferred growth | SPDA |
| Wants to save regularly for retirement | FPDA |
| Received inheritance, doesn't need income yet | SPDA |
| Working professional saving for retirement | FPDA |
Key Takeaways
- Immediate annuities begin payments within one year; deferred annuities postpone payments
- SPIAs convert a lump sum to immediate income—ideal for those needing income now
- SPDAs provide tax-deferred growth on a lump sum until a future annuitization
- FPDAs allow flexible ongoing contributions—suited for accumulating retirement savings
- Deferred annuities have surrender charges that limit early access
- All annuities have a 10% penalty on withdrawals before age 59½
- The choice depends on income needs, available funds, and time horizon
A Single Premium Immediate Annuity (SPIA) is characterized by:
Which type of annuity would be most appropriate for someone who wants to make regular contributions from their paycheck to build retirement savings?
A client receives a $500,000 inheritance and needs immediate retirement income. Which annuity type would best meet this need?
The primary difference between an SPDA and an FPDA is:
15.2 Fixed Annuities
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