What is an Annuity in Finance Explained Easy

Define Annuity in Finance

An Annuity represents a series of equal payments (or receipts) occurring over a specified number of equidistant periods or at some point in the future. Annuities are actually insurance agreements that offer a fixed income stream for individual’s lifetime or for a specified period of time. Annuities are often used as a way to fund for retirement. Annuities are optimized for long term growth.

 

How Do Annuities Work?

Annuity convert a lump-sum into a series of income that a person can’t survive. Social Security and investment savings are being needed Many retirees to afford their daily basis needs.

Annuities are intended to supply income through a process of gathering and annuitization or, in the case of immediate annuities, lifetime payments guaranteed by the insurance company that begin in a month of purchase.

when you purchase a deferred annuity, you actually  pay a best to the insurance company. That early investment will grow tax-deferred during the accumulation phase, usually anywhere from ten to 30 years, grounded on the terms of your agreement. Once the annuitization phase begins you will start getting regular payments.

Annuity contracts transfer all the risk to the insurance company  . This means annuity owner, are protected from market risk and longevity risk, which is, the risk of outliving your money.

To balance this risk, insurance companies charge fees for management of investment, and other administrative services. Besides, most annuity contracts include surrender periods during which the contract holder cannot withdraw money from the annuity without incurring a surrender charge.

 

Why Annuity Should be purchased

Publics purchase annuities to make long-term income. While many considered financial solutions for old people who are about to retired, but annuities can benefit investors of any age with a diversity of financial aims.

 

Reasons to buy an annuity include:

  • Long-term security
  • Principal protection
  • Probate-free estate distribution
  • Death benefits for heirs
  • Inflation adjustments
  • Tax-deferred growth

 

What are Types of Annuities

 

Ordinary Annuity

Payments or receipts occur at the end of each period.

Annuity Due

Payments or receipts occur at the beginning of each period.

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What is Annuity Formula

For Future Value

FV​=C×[ (1+i)n−1​\i]

For Present Value

PV​=C×[ 1−(1+i)−n​]​\i\

Whereas,

C=cash flow per period

i=interest rate

n=number of payments

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We will discuss more details about annuity and its numerical problem in next post so be in touch with students explore.

 

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