In the textbook, we use the term annuity to describe a periodic payment for a specified number of periods. In practice, annuities are often used as a retirement tool and are purchased from an insurance company. The insurance company will pay you periodic payments, either for a specified period, or until your death. If you want payments until your death, the insurance company calculates the number of payments based on your life expectancy. While you may outlive your life expectancy, the insurance company makes many such contracts and others annuitants will die before expected, reducing the risk to the insurance company. If you think annuities are rare, consider that Social Security payments are an inflation indexed annuity.
We are not giving you any advice on annuities because there are many different types and the purchase of an annuity may not work with your goals. With a deferred annuity, you make a deposit today, which grows until the annuity payments begin. Payments on an immediate annuity begin immediately. There are fixed annuities that offer a guaranteed rate of return, while variable annuities allow investments in stocks or bonds. Additional options can include basing the payment on one life or multiple lives, guaranteeing the return of principal, and whether or not the payments increase at the inflation rate. The decision to buy an annuity can be complicated, but it becomes much easier if you understand time value of money concepts.
