Annuity (finance theory)

An annuity is a series of payments made at equal intervals. Examples of annuities are regular deposits to a savings account, monthly home mortgage payments, monthly insurance payments and pension payments. Annuities can be classified by the frequency of payment dates. The payments (deposits) may be made weekly, monthly, quarterly, yearly, or at any other regular interval of time.

An annuity which provides for payments for the remainder of a person's lifetime is a life annuity.

Annuities may be classified in several ways.

Payments of an annuity-immediate are made at the end of payment periods, so that interest accrues between the issue of the annuity and the first payment. Payments of an annuity-due are made at the beginning of payment periods, so a payment is made immediately on issue.

Annuities that provide payments that will be paid over a period known in advance are annuities certain or guaranteed annuities. Annuities paid only under certain circumstances are contingent annuities. A common example is a life annuity, which is paid over the remaining lifetime of the annuitant. Certain and life annuities are guaranteed to be paid for a number of years and then become contingent on the annuitant being alive.

An annuity which begins payments only after a period is a deferred annuity. An annuity which begins payments without a deferral period is an immediate annuity.

Valuation of an annuity entails calculation of the present value of the future annuity payments. The valuation of an annuity entails concepts such as time value of money, interest rate, and future value.

If the number of payments is known in advance, the annuity is an annuity certain or guaranteed annuity. Valuation of annuities certain may be calculated using formulas depending on the timing of payments.

If the payments are made at the end of the time periods, so that interest is accumulated before the payment, the annuity is called an annuity-immediate, or ordinary annuity. Mortgage payments are annuity-immediate, interest is earned before being paid.

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