EDUCATION SERIES

Saturday Brain Storming Thought (87) 14/11/2020-By Vr Avinash Kulkarni

Annuity

It is defined as the net annual payment (return on investment) for the capital invested in an immovable property or any other form of investment

Examples of Annuity

1)Rent from land/house

2) Interest on fixed deposits

3) Yield on government security

4) monthly home mortgage payment

5) monthly insurance payment

6) pension payments

Annuity is a financial product that provides certain cash flows at equal time intervals

Annuities are created by financial institutions, primarily life insurance companies, to provide regular income to a client
An annuity is a reasonable alternative to some other investments as a source of income since it provides guaranteed income to an individual

However, annuities are less liquid than investments in securities because the initially deposited lump sump cannot be withdrawn without penalties

Annuities are primarily brought by individuals who want to receive stable retirement income

Types of Annuities

1) Fixed Annuties

Annuities that provides fixed payments. The payments are guaranteed, but the rate of return is minimal

2) Variable Annuities

Annuities that allow an individual to choose a selection of investments that will pay an income based on the performance of the selected investments

Variable annuities do not guarantee the amount of income, but the rate of return is generally higher relative to fixed annuities
3) Life Annuities

Life annuities provide fixed payment to their holders until his/her death

4) Perpetuity

An annuity that provides perpetual cash flows with no end date

Examples of financial instruments that grant perpetual cash flows to its holder are extremely rare

Valuation of Annuities

Annuities are valued by discounting the future cash flows of the annuities and finding the present value of the cash flows

PV = [ P/(1+r)] + [ P/(1+r)2] + [ P / (1+r)n]

PV = present value of the annuity

P = Fixed payment

r = Interest Rate

n = total number of periods of annuity payment

The valuation of perpetuity is different because it does not include a specified end date

In Perpetuity

PV = P / r

Annuity Value

The present value of an annuity refers to how much money would be needed today to fund a series of future annuity payments

Because of the time value of a money, a sum of money received today is worth more than the same sum at a future date.

Advantages of Annuity

1) you have a guaranteed regular income for the rest of your life

2) it’s tax paid

3) it takes the pressure off you by having someone else look after your investments. You can now sit back and enjoy your retirement

4) you may live a long time and make on the deal, at the expense of the insurance company

5) you know for certain that your capital will last your entire life

6) you do not pay tax on investment earnings

7) indexed annuities can protect you from the rising costs of living

8) some annuities allow you to nominate a loved on or dependent as a recessionary beneficiary

9) generally annuities carry no product fees

10) only the income component if any of an annuity purchased with non super money is taxable

Disadvantages of Annuity

1) if you die early, the insurance company gets to keep all the money, although it’s possible to secure a guaranteed pay out period

2) the annuity is not protected against inflation, again, it is possible to index link the annuity to offer some protection

3) the tax paid status of the annuity may be disadvantageous, if you are on a low marginal tax rate

4) your money is locked away, perhaps for decade

5) you can not choose how your money is invested by the fund manager

6) extra features have a cost

7) annuity might pay less than market-linked investment

Managed Funds

One advantage of investing through managed funds is the protection afforded to investors

Legislation dictates, among other things, the documentation that must be made available to prospective investors

The investment statement must be given to you before you sign up for the investment

You will sign a clause that you have read the investment statement

Possibilities of loosing money in annuities

The value of your annuity changes based on the performance of those investments

This means that it is possible to loose money, including your principal with a variable annuity if the investments in your account don’t perform well

Variable annuities also tend to have higher fees increasing the chances of losing money

Buying of an Annuity

You should not buy an annuity if social security or pension benefits cover all of your regular expenses, you are in below average health, or you are seeking high risk in your investments

Choosing of an Annuity

1) avoid buying too young or leaving it too late, in general, the older you are, the more annuity
2) buy when interest rates are higher

3) pay only for options you need

4) don’t pass up options you need just to get higher payments

5) don’t put all your savings in to an annuity

Pros of Annuities

1) guaranteed income

2) customised features

3) money-management assistance

Cons of Annuities

1) high commissions

2) high fees

3) surrender charges

4) tax penalties

Purpose and function of Annuities

Annuities provide cash contracts with an insurance company that are based primarily on equity investments and should be undertaken only as a long term program

An annuities Nasik purpose is to liquidate an estate through periodic payments

Annuities can be tailored to specifically suit individual needs

Annuity payments based on

1) starting principal

2) interest

3) income period

In Nut shell

A life insurance policy is based on creating an estate

Whereas

Annuity is based on liquidating an estate

Compiled by:-

Avinash Kulkarni

Chartered Engineer
Govt Regd Valuer
IBBI Regd Valuer

ANNUITY-ALL YOU SHOULD KNOW ABOUT-By Vr Avinash Kulkarni