In the textbook, we use the term annuity to describe a periodic payment for a specified number of periods. In practice, annuities are often used
as a retirement tool and are purchased from an insurance company. The
insurance company will pay you periodic payments, either for a specified
period, or until your death. If you want payments until your death, the
insurance company calculates the number of payments based on your life
expectancy. While you may outlive your life expectancy, the insurance
company makes many such contracts and others annuitants will die before
expected, reducing the risk to the insurance company. If you think
annuities are rare, consider that Social Security payments are an
inflation indexed annuity.
We are not giving you any
advice on annuities because there are many different types and the
purchase of an annuity may not work with your goals. With a deferred
annuity, you make a deposit today, which grows until the annuity
payments begin. Payments on an immediate annuity begin immediately.
There are fixed annuities that offer a guaranteed rate of return, while
variable annuities allow investments in stocks or bonds. Additional
options can include basing the payment on one life or multiple lives,
guaranteeing the return of principal, and whether or not the payments increase at the inflation rate. The decision to buy an annuity can be complicated, but it becomes much easier if you understand time value of money concepts.
