Perpetuities and Annuities - Essay Example

Running head: PERPETUITIES AND ANNUITIES Perpetuities and Annuities Educational PERPETUITIES AND ANNUITIES 2Perpetuities and Annuities Perpetuities and annuities make guaranteed payments at regular intervals. The former have an infinite lifespan, while the latter have a finite one. While there are different types of annuities, the most common is a retirement one. An annuity is often considered by people who may have insufficient retirement income from traditional defined pension plans and who are concerned that they may outlive their present income.

If the latter is a concern, then an investment broker will recommend the type of an annuity that cannot be outlived. Governments, whose employees terminate their employment with them prior to retirement age or having met a specified term of employment, hold the government and employee contributions until a minimum age and then begin paying an annuity (in actuality a type of reduced and deferred pension) for life to their former employees. Vanguard.com offers three types of annuities; namely, an immediate (income) fixed annuity; an immediate variable annuity; and a deferred variable annuity with a guaranteed lifetime withdrawal benefit (GLWB) rider, the latter not only meeting spending needs, but also guaranteeing that the annuity is not outlived. (2012). Immediate fixed annuities offer guaranteed fixed payments for a fixed period or for life.

They protect from market downturns and can protect against inflation. The amount of money that a retiree will receive from an upfront payment depends upon the person’s age and gender, the amount of the initial payment, the interest rates at the time of purchase, and the chosen options. If an annuity is purchased for a certain period of time (period-certain annuity), and the purchaser dies before the end of that period, payments can be made to beneficiaries for the balance of the time period (ibid.). PERPETUITIES AND ANNUITIES 3 A fixed immediate annuity can only be cancelled in very limited circumstances.

As a result, only part of one’s income should be used to buy such an annuity so that one still has some flexibility. With a GLWB, there is greater flexibility and control of one’s investment (ibid.). It should be remembered that “an annuity is a financial product issued by an insurance company. It allows for tax-deferred growth of assets. At retirement, an annuity can help to provide a guaranteed income stream for one or more people” (Hancock, 2012). Unlike an annuity, which has a fixed time, perpetuities go on forever.

As a result, they are less common than an annuity because people rarely set up payment structures that last forever. Charities, however, often set up this kind of structure. Investoverse.com gives the example of a scholarship set up so that each year until the end of time one student will get $5,000.00. To make this happen the charity must know how much money to set aside to make this happen. This is calculated as a perpetuity. It does not make much sense to this student to set up a personal perpetuity, although it makes more sense to do so in the case just stated of a charity that, amongst other things, gives a scholarship each year; and to make sure that it happens, sets it up as a perpetuity.

Considering that the time value of money available at the present time is worth more than the same amount in the future due to its earning potential, provided that it can earn interest (Time Value of Money – TVM, 2012), a fixed annuity with an upfront payment seems to be the preferable choice since the money begins to earn interest immediately thus increasing the value of the retirement instrument as opposed to a retirement annuity that has been built up over the years as a result of monthly payments.

For a long life expectancy, an annuity where the investor cannot outlive the annuity is best; otherwise, an immediate fixed annuity for a fixed time period. PERPETUITIES AND ANNUITIES 4 References Barclay, B. (2011, October 25). Differences between an annuity & a perpetuity. Retrieved on January 17, 2012, from http://www.ehow.com. Golden, S. (2009, January 22). Annuities and Perpetuities. Retrieved on January 17, 2012, http://www.investoverse.com. John Hancock. Retrieved on January 17, 2012, from http://www.

Johnhancock.com Time Value of Money. Retrieved on January 17, 2012, from http://www.investopedia.com. Vanguard. Retrieved on January 17, 2012, from http://personal.vanguard.com.