Annuities are financial instruments that guarantee a regular income stream, normally utilized for retirement planning.
They are provided by insurance firms and exist in several forms, each serving different financial objectives and risk tolerances. The most common annuity types are fixed, variable, indexed, and immediate or deferred annuities. A fixed annuity offers a guaranteed return, and a variable annuity changes according to market performance. An indexed annuity ties the best of both together, correlating returns to a financial indicator.
Annuities can also be sorted according to their payout arrangement—immediate annuities begin generating income immediately, while deferred annuities build up money over time before distributing payments.
Four Types of Annuities
There are four different types of annuities depending on the combination of two fundamental characteristics: payment time and payment frequency.
Ordinary Simple Annuity
An ordinary simple annuity is an annuity in which payments are made at fixed intervals, and the interest earned is reinvested in the annuity. The payments can be made monthly, quarterly, semi-annually, or annually. The payments can be made for a specified number of years or for the life of the annuitant. The interest earned on the annuity is taxed as ordinary income.
An ordinary simple annuity is a good way to save for retirement. The payments can be made from your paycheck or from your savings. The interest earned on the annuity is taxed as ordinary income, so you will not have to pay taxes on the interest until you withdraw the money from the annuity.
Ordinary General Annuity
A common general annuity is an annuity where payments are made at regular intervals, and the interest rate is constant. The payments are made at the end of each period, and the interest is paid at the start of the subsequent period. The principal is paid at the end of the term.
An ordinary general annuity is the easiest type of annuity, and it is also the most frequently used type of annuity. It is straightforward to comprehend and straightforward to compute. The payments are made periodically at fixed points, so no concern is faced regarding changing interest rates. The interest rate remains constant, and you know how much interest will be earned through the term of the annuity. The principal is paid at the term’s end, so you exactly know how much money you will have when the annuity is mature.
Simple Annuity Due
An annuity due is an annuity in which payments are made at the beginning of each period. This contrasts with an ordinary annuity, in which payments are made at the end of each period. Because payments are made at the beginning of each period, an annuity due has one more period than an ordinary annuity.
The present value of an annuity due is always greater than the present value of an ordinary annuity with the same payments and interest rate. This is because payments made at the beginning of each period are worth more than payments made at the end.
General Annuity Due
A general annuity due is an annuity in which payments are made at the beginning of each period rather than at the end. This type of annuity is typically used for business purposes, as the payments can be used to fund inventory or other short-term obligations.
The main benefit of a general annuity is that it provides a guaranteed source of income. This can be especially beneficial for businesses, as it can help them meet their short-term obligations.
The downside of a general annuity due is that the payments are made upfront, which can strain cash flow. Additionally, if the annuity is invested in a volatile investment, the value of the payments can fluctuate.
