In finance, an annuity is a series of fixed payments, usually over a fixed
number of years; or for the lifetime of a person, in which case it would be
called a life-contingent annuity or simply life annuity. A hybrid of these
is when the payments stop at death, but also after a predetermined number of
payments, if this is earlier: a temporary life annuity.
In each case the annuity may be immediate (payments start at the time of the
contract) or deferred (payments start at a predetermined later time).
An annuity is most often used to provide an income in old age, i.e. a pension.
An annuity may be purchased from an insurance company. In a typical annuity
contract, an individual would pay a lump sum or a series of payments to an
insurance company, and in return receive a fixed income payable for the rest
of his life.
A collection of algebraic shortcuts known as annuity functions are used to
model annuities, as well as a variety of other financial arrangements.
Because annuities generally give a series of guaranteed payments, they are
priced consistently with other guaranteed investments, such as government
bonds. These are less risky that other investments, such as the stock
market, and offer a lower expected return than these. (Sometimes annuities
offer higher guaranteed rates of return than those offered by bonds, but in
this case the annuity provider risks going bankrupt and possibly defaulting
on the policy, as has recently been happening in Japan.)
Thus annuities with dependable providers are suited to investors who are
risk averse and want a guaranteed return. Investors can expect a higher
return from other investments, but at the expense of taking a risk.
Annuities also sometimes have different tax treatment to other investments,
which may affect how attractive they are relative to other investments.
Investors will also receive a better return if they manage to live longer
than the annuity provider had predicted.
Annuities are a compulsory feature of certain savings schemes in some
countries, where the government grants tax deductions, provided that savings
are paid into a fund which can only (or mainly) be withdrawn as an annuity.
The United Kingdom and the Netherlands have such schemes. From 2003 the tax
deduction in the Netherlands is only allowed if, without additional savings,
the old age income would be less than 70 % of the current income.