Immediate variable annuity
An immediate variable annuity is a financial contract between you and an insurance company. You give the company money now and the company pays you an income at a later time.
Income annuities can be fixed or variable. The payments from variable income annuities discussed here fluctuate and are based on the performance of the investment options you choose. Although payments may go up or down, variable annuities are designed to provide income that can rise over time to help you keep pace with inflation. Immediate annuities are often designated as Single Premium Immediate Annuities (SPIA) to differentiate them from deferred annuities.
Investments in an immediate variable annuity are placed in what is termed a Separate Account, which is an account segregated from an insurer's general account and is exempt from the insurer's creditors. Investors are provided with a menu of subaccounts, pooled investment vehicles analogous to mutual funds, offering access to stocks, bonds, and money market instruments. The annuity investor's capital will fluctuate with the returns of the underlying subaccount investments. The terminology used in connection with a subaccount, along with the analogous mutual fund terminology is provided in the following table:
|Variable Annuity||Mutual Fund|
|Accumulation Unit||Mutual Fund Share|
|Accumulation Unit Value||Net Asset Value|
|Accumulation Value||Account Value|
The basic construct of an immediate variable annuity (SPIA) is the annuity unit. The unit is computed according to three factors applied to the specific chosen distribution option and life expectancy of the investor:
- The monthly payment per $1,000 invested. Using an assumed interest rate (AIR) and mortality assumptions, an actuary can price the initial annuity payment.
- The amount invested.
- The accumulated unit value (AUV) of the underlying subaccount portfolio.
As a simplfied example, assume that the actuary provides a $6.00 monthly payment per $1000 invested; an investor invests $50,000 in a balanced subaccount fund; and the AUV of the subaccount fund is $10.00. The following computation yields the number of annuity units.
(50 x 6.00)/10.00 = 30.00 annuity units. The initial monthly income from this subaaccount fund would, in this instance, equal 30.00 x 10.00= $300.00. 
This is the key to the insurer's lifetime income guarantee. With a life annuity, the annuitant will be paid 30.00 annuity units for life. Gross fund performance minus fund and insurance expenses, and the AIR will determine the ensuing payments.
Assumed interest rate (AIR)
The AIR assumes two pivotal valuation functions for a variable SPIA. It determines the initial annuity income payment as well as the variable adjustments to income. The AIR usually ranges from 3% to 7%. Vanguard  and TIAA-CREF  use a 4% AIR in their existing VA contracts.
The higher the initial AIR, the higher the initial payment. Later income appreciation will be slower with a high AIR, and income losses likelier. A lower AIR results in a smaller initial income, but produces faster income appreciation, thus providing better hedging against inflation risk, as well as smaller income losses during down markets.  It is important to note, however, that all AIR income streams are actuarially equivalent. In addition, because the AIR discount rate is applied to the more reliable expected mortality experience of a pooled cohort of annuitants, the initial income payout for an annuitization of a lump sum (for retirement age annuitants) is frequently higher than the income from an equal systematic withdrawal rate applied to the same lump sum. Below are the monthly income implications for both a 3.5% AIR and a 7% AIR, assuming 10% and -10 % returns:
- 3.5% AIR
- 10 percent gain: (1.10/1.035-1)= 6.28%
- 10 percent loss: (0.90/1.035-1)= -13.04%
- 7.0% AIR
- 10 percent gain:(1.10/1.070-1)= 2.80%
- 10 percent loss:(0.90/1.070-1)= -15.89%
The exclusion ratio
Variable immediate annuities receive a degree of tax relief (for non-qualified dollars) due to the income exclusion rules. The IRS allows the investment in the contract to be recovered over the annuitant's life expectancy. In our previous example of a $50,000 initial investment and a 20-year life expectancy, approximately $2500 of the annual income stream would be a tax-free return of principal for 20 years. After year 20, the full income payment will be taxed. If the owner dies before the total investment in the contract is recovered, and annuity payments cease as a result of his death, the un-recovered amount is allowed as a deduction to the owner on the final tax return. 
Fundamental common benefits
Almost all variable SPIAs allow the investor to chose an initial asset allocation for the portfolio. After annuitization, the investor loses control of the invested capital, but can still maintain control of the asset allocations of the underlying portfolio. This allows the investor to maintain control of the expected returns and risk parameters of the portfolio income stream. Many immediate variable SPIAs also allow the investor to reallocate annuity units into the insurer's general account and the fixed immediate annuity payout option.
Usually the investor is given flexibility in timing the investment stream (monthly, quarterly, annually) as well as the periodicity of the variable income adjustments (monthly vs. annually).
Common income options for immediate variable annuities include the following four optiions.
- Single life annuity: As the annuitant, you receive regular income payments for your lifetime, ending at your death. (Payments are largest with this option.)
- Joint and survivor annuity:Payments are made as long as you (the annuitant) or another person (the joint annuitant), such as your spouse, are living. Many annuities allow you to select a percentage (50%, 66.67%, 75% or 100%) of the amount that was payable while the annuitant was alive to go to the joint surviving annuitant.
- Single life with a guarantee:As the annuitant, you receive payments as long as you live, but not less than a guaranteed period. If you die before the period ends, your beneficiaries receive the remaining payments. The guaranteed period may cover 5 to 50 years for nonqualified (after-tax) assets and up to your life expectancy for qualified (pre-tax) assets.
- Joint and survivor with a guarantee:Payments are made as long as you (the annuitant) or another person (the joint annuitant) are living, but not less than a guaranteed period. If both you and the joint annuitant die before the period ends, your beneficiaries receive the remaining payments. The guaranteed period may cover 5 to 50 years for nonqualified (after-tax) assets and up to your life expectancy for qualified (pre-tax) assets. 
The addition of a guarantee option will reduce the income payment from the annuity.
Commutation and withdrawals of principal
Many immediate variable annuities grant an annuitant who has selected a life annuity with a guarantee period the right to commute the annuity stream into a lump sum payment. Reflecting the reduced capital providing for the income stream, a commutation results in both a lower ensuing income and a shorter guarantee period. 
If the variable SPIA offers a Guaranteed Minimum Withdrawal Benefit (at a higher cost) this optional benefit guarantees, regardless of market performance, that you will be able to receive at least the entire amount of your total principal investment through a series of annual withdrawals – provided that you do not withdraw more than a specified percentage of your total investment in any given year. Some variable annuities are now offering this benefit with the guarantee that you can make withdrawals for as long as you live. 
- Vanguard Lifetime Income Program - SPIA
- Vanguard Variable SPIA: using Vanguard Inflation Indexed Securities Fund for inflation protection
- Vanguard Variable Annuity Prospectus, 2008.
- Daily, Glenn, S. “The attractions and pitfalls of variable immediate annuities,” AAII Journal, (February 1994)
- Vanguard VA Prospectus p.10.
- CREF Annuities prospectus p.101.
- Vanguard Lifetime Income prospectus p.32.
- Babbel, David F., and Reddy, Ravi, "Measuring the Tax Benefit of a Tax-Deferred Annuity", Wharton Financial Institutions Center Policy Brief: Personal Finance, (October 4, 2008}
- Merkel, Stephen,Selecting The Payout On Your Annuity Investopedia
- Commutation on Life Income Payments policy illustration
- Devine, Colin, Hunt, Heather L. and Walsh, Keith, "The New Variable Annuity" Smith Barney (September 14, 2004). p.21.
- Vanguard: Should you consider an Income Annuity, (from bob90245, Bobsfinancialwebsite)
- A More Perfect Mix Jim Otar (June 1, 2003)
- bob90245 has completed a four-part series of articles on Immediate Annuities:
- (defunct link) Annuities: A Primer
- (defunct link) Pros and Cons of Immediate Annuities
- (defunct link) Immediate Annuities in Retirement
- (defunct link) Immediate Annuities Links Page
- A Forbes.com tutorial series by forum member Mel Lindauer:
- Insured Retirement Institute
The following papers are technical. They deal with the economic pricing of Variable Annuity benefit riders. The papers allow one to measure the cost/benefit trade off for each insurance benefit.