Annuity premium and timing structures

Two questions classify every annuity

Every annuity can be described by answering two separate questions:

1. How is the premium paid? All at once, on a fixed schedule, or whenever the owner chooses.
2. When do the income payments start? Right away, or at some later date.

The answers combine into the product names you will see on the exam, such as a single premium immediate annuity (SPIA) or a flexible premium deferred annuity (FPDA). Keep the two questions apart and these names decode themselves.

Premium structures: how money goes in

• Single premium. One lump-sum payment buys the contract. No further deposits are made. A single premium can fund either an immediate or a deferred annuity.
• Periodic (level) premium. The owner pays a set amount on a regular schedule, such as monthly or annually, much like a life insurance premium. Because later payments are due on dates, the contract gives a 31-day grace period after each payment after the first, during which the contract stays in full force.
• Flexible premium. The owner may pay varying amounts at varying times, within the insurer's minimums and maximums. Excess interest accumulation annuities commonly allow either single or flexible premiums.

Periodic and flexible premiums only make sense with a deferred annuity: there must be time to make the payments before income begins.

Timing structures: when money comes out

• Immediate annuity. Income payments begin within 12 months of purchase. Because payout starts so soon, an immediate annuity is purchased with a single premium. Payments are generally equal and made monthly, quarterly, semi-annually or annually.
• Deferred annuity. Income payments are not scheduled to begin for at least 12 months. They start at the maturity date stated in the contract or, if earlier, a date the owner selects.

The two phases of a deferred annuity

A deferred annuity that holds an account value has two phases:

• Accumulation phase. Premiums, less expenses, are credited to an account that grows with interest or investment earnings on a tax-deferred basis. The owner can usually make withdrawals, subject to any surrender charges.
• Payout (annuity) phase. At annuitization, the owner converts the accumulated value into a stream of income under a chosen income option. The contract may name a maturity date, but usually allows annuitization any time after the first year.

An immediate annuity effectively skips the accumulation phase and goes straight to payout.

A deferred annuity without an account value

Not every deferred annuity accumulates. A paid-up deferred annuity, also called a deferred income annuity (DIA), uses each premium to buy a fixed future income amount that begins on a set date, such as retirement. It keeps no account value, and its cost is much lower than an immediate annuity's for the same income. Longevity annuities and Qualified Longevity Annuity Contracts (QLACs) are examples, with income often deferred to around age 85.

Putting it together

Exam pattern: "Single premium" never tells you the timing; "immediate" always tells you the premium was single.

The valid combinations are:

• SPIA: single premium, immediate payout.
• SPDA: single premium, deferred payout.
• Periodic or flexible premium deferred annuity (FPDA): a series of payments, deferred payout.

There is no "flexible premium immediate annuity": a series of deposits cannot be made before income starts within a year.