What is Single Premium Deferred Annuity?

 The name of the single-premium deferred annuity (SPDA) is truly descriptive, as it is a deferred annuity contract purchased with a single premium. As with the FPDA, a minimum stated rate of interest is guaranteed for the duration of the contract, but most insurers credit competitive market rates. The rate actually credited is a function of the insurer’s current investment earnings rate and its desired competitive posture in the market, and it is subject to change by the insurer, just as with the FPDA. The current rate may be guaranteed for a single year or for as many as three or more years generally, the longer the guarantee period, the lower the rate. Many insurers follow a tiered rate approach wherein the first tier of funds received (e.g., $25,000) is credited with one interest rate, and funds received in excess of this tier are credited with a somewhat higher rate (e.g., 0.25 percent higher). Some companies have as many as four tiers, each of which attracts a higher rate.

The single premium is often unreduced by identifiable front-end loads. Provision is usually made for graded surrender charges, similar to those for the FPDA, and for withdrawal corridors with no surrender charges. SPDA contracts often have bailout provisions that stipulate that if the interest rate actually credited to the SPDA cash value falls below a set rate (often set at 1 to 3 percent below the current rate being credited); the contract owner may surrender without incurring any surrender charge. This provision is valuable, but any such withdrawal could result in a tax surcharge. Also, if the insurer felt compelled to so reduce its credited interest rate, this probably would occur because overall market interest rates had fallen significantly. Therefore, it might prove difficult for the contract owner to find comparable financial instruments crediting a higher rate.

Market-Value Annuity The market-value annuity (MVA) (also referred to as a market- value adjusted annuity) is a type of SPDA that permits contract owners to lock in a guaranteed interest rate over a specified maturity period, typically from three to ten years. First introduced in the United States in 1984, the MVA is increasingly included as an option with variable annuities. If kept until maturity, its tax-deferred value reaches the amount guaranteed at issue. However, unlike the situation with other fixed-value annuities, if withdrawals occur, the cash value will be subject not only to possible surrender charges but also to a market-value adjustment. The adjustment may be positive or negative, depending on the interest rate environment at surrender. If interest rates at surrender were higher than those at time of issue, the adjustment would be negative. Conversely, if rates were lower, the adjustment would add to the cash surrender value. The adjustment is intended to reflect the changes in market values of the assets—typically bonds—backing the annuities. Thus, as interest rates rise, the market values of previously purchased bonds decline, and ‘vice verse, all else being equal.

The theory for MVAs is that, if the actual available cash surrender value reflects this market value, the insurer, in effect, shifts much of the risk of market-value changes of assets to the contract owner. Insurers can limit their disinter-mediation risk (i.e., the tendency to surrender during an increasing interest rate environment) and better match the duration of assets backing the MVA with its corresponding liabilities. The MVA is less flexible than many other annuities, but it can offer advantages to buyers. For one thing, there is the possibility of a positive adjustment. For another, the typically longer-duration guarantee can afford a greater sense of security. Also, in theory, the MVA should be able to offer higher interest credits than an equivalent-duration SPDA, as the buyer bears more risk.

Certificate of Annuity Another SPDA variation is the certificate of annuity (COA), first offered in the United States in 1983, which provides for a fixed, guaranteed interest rate for a set period of time, typically three to ten years. It is similar to a bank-issued certificate of deposit, except that, as an annuity, interest earnings are tax deferred. The COA differs from other annuities in that no unscheduled withdrawals are ordinarily permitted during the guarantee period. The full cash value is available on death and annuitization. At the end of the selected guaranteed period, the owner can renew the COA for another period or select any of the standard annuity options. Many insurers’ products carry no identifiable front-end or back-end charges. As the contract does not permit early, unscheduled withdrawals, the interest rate credited to the cash value should be quite competitive, other things being the same. The contract is appealing to individuals who are near retirement, have little prospect of needing the funds during the guarantee period, and are interested in locking in an interest rate. The SPDA can be an important element in a retirement program. As with all insurance contracts, the contract should suit the needs of the client, and the insurer offering the product should be reliable.