Insurance companies offer features that can be added on to an annuity to address the problems. They also have some drawbacks, such as a rate of return that may not keep pace with inflation or a payout that ends when the holder dies, regardless of how much money was paid out. Simple annuities are easy to value, so the people who sell them don’t make much money. This is unlike a bond or CD, where you own taxes on each year’s interest earnings. And, while they earn interest, you don’t pay taxes until you receive a payment. At the most basic level, an annuity can be a low-cost way to guarantee steady money. What an annuity does is convert savings into regular income: You pay money now to receive a regular income in the future.
If you remember this concept of annuities as a stream of payments, then you are in a better position to evaluate any annuity offerings that come your way. You can make larger monthly payments for 15 years or smaller payments for 30 years on the same amount borrowed. In exchange for money to buy a house, you agree to give the bank a regular stream of monthly payments that include both repayment of the amount the bank gave you (principal) and interest on the outstanding balance. When you take out a mortgage, you are essentially giving the bank an annuity.
It’s easy to find online calculators that help you find the value of a simple annuity.Ĭonsider the example of a mortgage. The concept applies to many different financial calculations, from loan payments to required minimum withdrawals for retirement plans. Mathematically, each payment is discounted by an interest rate that reflects the amount of time it will take to receive it, and the total is the amount that you pay.
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