Is an annuity a perpetuity?
An annuity can be a perpetuity, depending on how it is set up. An annuity is an investment that makes regular payments throughout the year. A perpetuity is a type of annuity that is set up so that the payments never end. As long as an investor owns a perpetuity, he will keep receiving payments. When the investor dies, the perpetuity will pass on to his heirs and keep making payments as normal. If the investor sells the perpetuity, the new owner will receive the payments.
Most annuities eventually stop making payments. They might stop making payments after a set number of years or after the contract owner dies. However, if an annuity is set up so that it never stops making payments, then it is a perpetuity. In other words, all perpetuities are annuities, but not all annuities are perpetuities.
Examples of Perpetuities
Because of their extremely long, potentially infinite time frame, perpetuities are relatively rare investments. Annuity companies don't sell perpetuities. The closest example of a true perpetuity is a type of bond from the British government known as a consol. These bonds have no maturity date and keep making interest payments forever - or at least as long as the British government is in existence.
Preferred stock in companies can also resemble perpetuities. Some preferred stock is sold without an expiration date. These stocks pay out a fixed dividend rate out of the company's profits. This structure resembles a perpetuity; as long as the company is in business and making a profit, the preferred stock will pay out its set payments.
An annuity could be a perpetuity while an annuitant is alive and to his/her lifetime, but it will stop upon the annuitant’s death. That’s why the annuity can be a valuable tool for a person’s retirement.
When you retire, the sudden stop of the regular paycheck can cause anyone anxiety. Even for anyone who has a cushy retirement account, the slight market volatility can cause the account owner to wonder if he/she is able to withdraw the same amount this year. By allocating a portion of one’s investment account to annuity, you know you just have created your own paycheck for life. That’s one of the reasons that retirees who retired with a pension rates higher security and satisfaction regarding their investments and retirement than the retirees who don’t.
Moreover, having the annuity gives you the freedom and mentality to take a little bit more risks than you would otherwise for your portfolios. The traditional investment strategy for retirees may be safe/secure (think CDs and bonds), but yields are too low to hedge against a rising inflation environment. The payment of most annuities stays the same year after year. Do you know one dollar in 1963 is only worth thirteen cents in 2016? That just goes to show the risks of three decades of time that can dramatically reduce retirees’ purchasing power if the retirees solely rely on annuity.
To summarize, annuity is good because it appeases one’s psychology, but it needs to be paired or added to the overall investment management strategy to truly provide the peace of mind for the retirement. Enjoy!
The definition of a perpetuity (as a noun) is "a bond or other security with no fixed maturity date." In the sense that you have an income annuity such as a Single Premium Immediate Annuity (SPIA) or if you are taking income from a lifetime income rider, then the idea that it will last for the length of your life makes it similar to a perpetuity. Most annuities sold today are NOT SPIA's, but are fixed deferred annuities that are more like a CD or a bond that can have annual interest credits. They also have a penalty for an early surrender or withdrawals over a certain amount.
If you are talking about Annuitization (monthly distributions), then normally it is set to your lifetime. But, the normal lifetime annuity stops when you die. So, if you get hit by a bus a month after annuitization, then payments stop. If you live to age 105, payments continue until you die. This is the uncertainty of giving up a lump sum in exchange for "guaranteed income." Some people will chose over their lifetime, but with 10 years "sum certain" so that if they die prematurely, some heir will get payments over the remaining 10 years. You will, however, get lower monthly distributions.
What I am telling you is that there are all types of options when annuitizing. You must chose wisely because the decision is irrevocable. I would say you should shop around the lump sum to different insurance carriers and let them know it is a competitive bid to ensure you are getting the best deal.
Hope this helps and do your research. Dan Stewart CFA®
Not always. An annuity typically refers to a level of payment obligation (i.e. $5,000 per year for x years). A lifetime annuity provides for such payments during your lifetime; a joint and survivor annuity provides for payments during the longer of your or your spouse's lifetime. A fixed annuity typically provides for a certain, stated number of years of payment. Make sure you read the prospectus (including all of the fine print) related to any prospective investment, or consult with a fee-only advisor whose interests are aligned with yours.