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Annuity is a financial product in the form of an insurance contract that provides a guarantee of payment within a specified period. Before investing in an annuity, it is very important to understand what the pros and cons are. The purpose of an annuity is usually to provide a steady flow of funds during retirement.
With an annuity, retirees don't have to worry about spending funds from the assets they have, and can finance retirement with a lifestyle similar to their active age. For this reason, investors will turn to insurance companies or other financial institutions to purchase annuity contracts.
It can be concluded, an annuity contract is very suitable for investors who want stability and guaranteed fixed income in their old age. For young investors who need liquid investment instruments or easily liquidated at any time, annuity contracts are not recommended, because they do not suit their needs.
What is an Annuity Rate?
To be able to determine the calculations in an annuity, there is the term annuity rate . An annuity rate is a valuation method for determining how much to pay. This valuation really depends on the interest rate and value in the future and the valuation chosen.
Annuity formula
To calculate an annuity, of course, cannot be careless. There is an annuity formula that you can use, namely:
PV = P x 1 – (1+r)ˉⁿ : r
PV = current value of the annuity
P = value of each payment
r = interest rate per period
n = number of periods.
Actually, there are many ways to calculate an annuity, but the annuity interest formula above is the one most often used. The current value of the annuity is highly dependent on currency values. According to Harvard Business School, the value of money is more valuable today than it is worth in the future. One of the main causes is the unpredictable economic conditions.
Annuities are divided into various types, depending on the details and factors that influence them. For example, based on the duration of time or other things. Following are some types of annuities:
Immediate Annuity and Deferred Annuity
Based on the time of payment, annuities are divided into immediate and deferred annuities.
An immediate annuity is a type of annuity that starts immediately after the investor makes a deposit. So, the annuity payment will be immediately given to the contract owner as soon as the deposit is made. Usually, this type of contract is chosen by a retired person or spouse.
On the other hand, there is a deferred income annuity . A deferred annuity is an annuity in which payments to the owner are not immediately made once the first deposit is made. Instead, annuity owners will choose specifically at what age they want to start receiving annuity payments.
Fixed Annuity and Variable Annuity
In addition, based on the amount and frequency of payments, annuities are divided into fixed and variable annuities.
A fixed annuity is a type of annuity that provides regular payments of a fixed amount to the owner.
Meanwhile, a variable annuity is a type of annuity that provides periodic payments in an amount that decreases each period to the owner.
Maturity Annuity and Lifetime Annuity
Apart from that, there are also annuity due and annuity for life. A life annuity is a type of annuity in which payments continue until the beneficiary dies.
Whereas, an annuity due is a type of annuity in which the beneficiary may still receive a refund of the remaining principal. It could also be the heirs who receive, if the owner of the annuity dies.
Annuity Example
To understand more about annuities, see the following examples of annuity calculations .
A life insurance policy is an example of a fixed annuity that requires the beneficiary to pay a fixed amount each month for a predetermined period of time (usually 59.5 years). With this insurance, the owner will receive a steady income during their retirement.
Meanwhile, an example of an immediate annuity is when the owner of the annuity pays a single premium, for example Rp. 20 million, to an insurance company. Then, they receive fixed payments each month of IDR 1 million, within a certain period. The amount of the immediate annuity payment usually depends on market conditions and interest rates .
One criticism of annuities is that they are illiquid. Deposits for annuities will usually be locked for some time, so they cannot be taken back by the owner if needed at any time. This period is called the surrender period . The owner of the annuity can ask for the deposit to be withdrawn, but of course there is a penalty that must be paid. Usually. The surrender period lasts a maximum of 10 years.
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