Variable annuity is usually classified according to when the investor wants to receive returns on his or her investment. There are two major types of variable annuity, the immediate variable annuity and deferred variable annuity.
In a deferred variable annuity, the individual receives a return on their investment at a later date and this type of variable annuity is subject to compounded growth as well as tax deferral during the accumulation stage.
In an immediate variable annuity, the paycheques start coming immediately. Sometimes within a month or a year depending on the periodic payment periods agreed between the investor and the insurance company. Therefore, the investor receives dividends on this type of variable annuity immediately after it is purchased, and the individual is guaranteed to receive the income for as he or she is alive.
In an immediate variable annuity plan, the investor usually makes a lump-sum deposit which is put in a portfolio and the investor can spread these funds across different assets. The investor can choose to purchase bonds or stock and they will get payments depending on the performance of their investment in that particular year.
The investor who opts for an immediate variable annuity instead of a deferred variable annuity has to let go of the possibility of compounded growth which is enjoyed in deferred variable annuity as they start receiving the funds immediately. They also start paying income tax on their withdrawal immediately because they start withdrawing funds as soon as they purchase the variable annuity, without allowing the funds to accumulate.
Immediate variable annuity carries a lot of potential risk because it is equity based. Therefore, the returns are usually different for the investor depending on the performance of their asset class in the money markets. If their investments performed well during a particular year, their accounts are likely to be more valuable meaning that they will get higher payments. However, if their investments perform poorly during the year, their accounts will reduce in value and ultimately, the payments that they receive will be less. Because withdrawals are not deferred, there is no ‘surrender charge’ in an immediate variable annuity for early withdrawals.
In immediate variable annuity, the investor is guaranteed an income for life and there is the potential that their investment will increase and their account will have a higher value with time. There is no possibility of the individual outliving their funds and they will receive monthly or yearly payments for the rest of their life.
This type of variable annuity is best for individuals who have already retired as they can start getting their funds immediately. They are also cushioned from the risk of investing over a long period of time, as accounts can lose significantly after a long time, though they can also gain significantly after a long period of time. The retirees can start getting a paycheque immediately, though the payment rate is dependent on the performance of their investment. It is important to read the details of the prospectus offered by the insurance company in order to know all the terms that apply to this type of variable annuity.