An annuity is a financial product which allows you to make a series of fixed payments at equal time intervals. Annuities are created and sold by financial institutions, which invest funds received from individuals and then, upon annuitization, issue a stream of payments at a later point in time. The period in which an annuity is being financed and no payouts begin is referred to as the accumulation phase. Once payments are being made to the individual funding the annuity then the contract is in the annuitization phase. Examples of annuities are monthly mortgage payments, monthly insurance payments, monthly pension payments and regular deposits to a saving account. An annuity which covers payments for the remainder of an individual’s lifetime is referred to as life annuity.
Valuation of an annuity basically includes the calculation of the present value of future annuity payments. The annuity valuation revolves around the concepts of interest rates, present value, future value and time value of money.
Annuities mainly come in three main varieties which are as follows:
- Fixed Annuities – These are annuities that payout a guaranteed amount depending on the amount of the investment made.
- Variable Annuities – These are annuities that basically provide you with an opportunity to make direct investments into a number of funds.
- Indexed Annuities – These are annuities that provides you with the benefit of receiving guaranteed minimum payments although a portion of your payments are linked with the performance of a market index.