The term “annuities” usually refers to retirement plans that pay a fixed or variable income with a guaranteed minimum to the account holders. But in general, annuities are any payments of equal amounts you make or receive at regular intervals. A perpetuity and an ordinary annuity are both types of annuities. What distinguishes them from each other is the duration of their payments.
Perpetuity payments do not have an ending date and are calculated to last forever. These types of annuities exist in different forms. An insurance company might sell securities that guarantee a minimum small return forever. Or a scholarship fund makes a gift of $10,000 to a different student every year, for example.
Ordinary annuity payments are set up to last a limited time even though they may last over a long period. In addition, these payments occur at the end of a payment cycle. The quarterly dividends an investment account pays out are an example of an ordinary annuity. Rent due on the first of the month, on the other hand, is its opposite and is known as an annuity-due, because the payment is owed in advance in the beginning of the monthly cycle.
Annuity Savings’ Advantages
As a savings option, annuity contributions earn interest and are tax deferred until you begin to make withdrawals. You may make unlimited deposits into the account and increase the principal balance on which interest is calculated. Also, although in a standard annuity’s setup you receive equal payments for a limited time or in perpetuity, you may also opt to withdraw the entire balance as a single distribution. But a large withdrawal might not be the most advantageous choice unless you have high deductions to lower your taxable income for that year.
Annuity Savings’ Disadvantages
High and multiple fees are the less appealing features of annuity savings. The account is subject to surrender fees if you withdraw the money within the first couple of years, and these range from 7 percent to 20 percent, according to CNN Money. The fee goes down with each year the balance stays untouched. You also owe account maintenance fees that total about 3 percent of your balance annually. If your annuity is set up as a retirement fund, you’ll be charged a 10 percent penalty in addition to income taxes if you take a distribution before the age of 59 1/2.
- U.S. Securities and Exchange Commission: Evaluating Your Retirement Options
- TVMCalcs.com: Time Value of Money Terminology
- Investoverse.com: Annuities and Perpetuities
- The Pennsylvania State University: Time Value of Money (TVOM) Tutorial
- David R. Frick & Company: Time Value of Money Concepts
- CNNMoney: What Are the Advantages of Annuities?
- CNNMoney: Ultimate Guide to Retirement: What Are the Disadvantages?
- Calculating payments image by Christopher Meder from Fotolia.com