Variable Annuity Types

Discussions of variable annuities generally involve comparison with other investment products, such as mutual funds. This is necessary and valuable, but the implication is that differences in variable annuities themselves are unworthy of consideration. That is untrue; differences among variable annuities and variable annuity types merit discussion.

Deferred Variable Annuities

Far and away the leading variable annuity type is the deferred variable annuity. Deferral means that the annuity distribution date does not fall within one year after purchase of the annuity contract, but is instead held off for some period of years. Deferral allows time to accumulate the capital sum necessary to fund the annuity; it lubricates the investment phase of retirement planning.

Fixed annuities credit the annuityholder with interest on the periodic sums saved during the accumulation phase of the annuity. The fixity in the name derives from the fact that the credited rate is fixed in advance, although it may change at annual intervals. A variable annuity allows the credited return to vary directly over time with marketplace conditions. In a fixed annuity, the insurance company invests the contributions made by the annuityholder in order to fund the interest credited to the annuityholder. In a variable annuity, the annuityholder controls the investment of his or her periodic payments. The investments are made in various sub-accounts that are equivalent to mutual funds. The investment options available to the annuityholders include stocks, bonds, a combination thereof, or a money-market mutual fund.

The time period over which accumulation occurs is stipulated in the annuity contract. At the end of the accumulation period, distribution of annuity proceeds commences. If the annuityholder chooses to annuitize the distribution of the accumulated funds, the holder will receive guaranteed income for life. Annuitization requires the annuityholder to relinquish the control of the funds that was exercised in the accumulation phase. Alternatively, the holder can opt for scheduled withdrawals from the accumulated proceeds without ceding control over the funds.

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Immediate Variable Annuities

The original annuity type was the immediate fixed annuity. The general idea was the same as that of its later relative, the deferred fixed annuity. The annuityholder gives money to the insurance company, which invests the money and provides the annuityholder with guaranteed lifelong income. The difference is that the immediate annuity begins the distribution phase within one year from the purchase of the annuity contract. (The precise delay depends on the payment frequency selected by the annuityholder; monthly payments would imply that the first distribution payment would be made one month after annuity purchase.) The holder must provide a sufficient capital sum to fund distributions quickly after purchase.

Just as does a deferred variable annuity, an immediate variable annuity requires the purchaser to pay the insurance company to fund later distributions. As with the deferred variable annuity, the holder controls the investment of the payments, rather than being the passive beneficiary of insurance-company investment.

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Suitability of the Different Variable Annuity Types

Purchases of deferred variable annuities are quite common, while immediate variable annuities are much rarer. Deferred variable annuities are a logical investment alternative for certain classes of investors; immediate variable annuities contain inherent contradictions and tensions that severely limits their appeal.

Deferred variable annuities are usually unsuitable for younger investors because they contain surrender charges that penalize withdrawals during the accumulation period. They are primarily retirement-planning vehicles. Withdrawals before age 59 ½ are hit by a 10% penalty imposed by the IRS. Deferred variable annuities contain certain (explicit and implicit) insurance features – such as minimum guaranteed benefits and death benefits – that add to their cost.

They are suitable for older investors in the retirement planning stage of life, at which time benefits become more beneficial and their costs become less onerous. Older investors have more money to invest and less need for liquidity. Their need for tax-deferral is more likely to outstrip the contribution limits contained in tax-advantaged retirement plans. Longer life expectancies make the growth orientation of equity investment more valuable to them. Eventually, in old age, the need for liquidity and safety will dominate the desire for growth, making deferred variable annuities once more a dubious choice.

Immediate variable annuities contain an inherent contradiction. Immediate (more or less) distribution of income by the annuity implies that retirement has already begun, since that is the time when people need to replace the loss of earned income. But retirement is traditionally the time when people are transitioning out of growth-oriented investments and into safer, income-oriented investments. In retirement, it is much more difficult to recover from losses suffered in market downturns, since it may be difficult or impossible to earn money and there is less time for growth compounding to work its exponential magic on savings.

The fact that immediate variable annuities do find buyers is due to modifications in the traditional outlook. These modifications stem from the large increases in life expectancy realized in the 20th century. Those increases apply not only to life expectancy at birth but to life expectancy at retirement age as well. With average life expectancy at age 65 extending into the 80s and the variance around the average extending past age 100, the need for investment growth does not die at age 65 but lives on well into retirement.

Even so, the suitability of immediate variable annuities in retirement is probably limited to those who need the income growth most urgently in order to avert wrenching changes in their lifestyle.


The two major variable annuity types are deferred and immediate variable annuities. Technically, they differ in the same way that deferred and immediate fixed annuities differ – delayed distribution of annuity proceeds as opposed to immediate. This difference is profound for variable annuities, much more so than for fixed annuities. Because variable annuities were designed to graft an insurance product onto an investment vehicle, deferral makes sense. It furthers the investment objectives of the product. In contrast, immediate distribution runs counter to those objectives. The result is that while deferred variable annuities are suitable for a large class of people in a key phase of their financial life cycle, immediate variable annuities are suitable only for a narrow class of people over a short time period.

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