Annuity vs Perpetuity
Annuities and perpetuities are terms that are very important for any investor to know and understand since they both refer to types of financial payments made. An annuity is a repayment made periodically for a set period of time, whereas a perpetuity is a periodic repayment that has no end. Due to the similarities between the two, they are often misunderstood. The following article provides a clear overview of each form of payment and how they are similar or different to one another.
What is an Annuity?
An annuity is known as a financial asset that will periodically pay a set amount of cash over a defined period of time. Annuities commonly are a part of retirement plans where an investment is made by an individual who will receive an inflow of funds regularly as they retire. An annuity is recognized as a financial contract that is made between an individual and a financial institution. The individual will pay a lump sum at the beginning of the period or make a set of deposits on a set schedule to a financial institution such as an insurance company, and the financial institution will make regular payments to the individual for a previously agreed fixed period of time.
The financial institution will accept the individual’s deposits and invest them in various financial assets so that the funds can be grown and regular payments can be made. There are a number of different types of annuities, and the one chosen will depend on the type of returns that the investor requires and the level of risk that they are willing to take.
What is Perpetuity?
Perpetuity is referred to as a stream of cash flows that will be paid at regular intervals, and will continue for an eternal period of time. One of the best examples of perpetuity is the bonds issued by the British known as Consols. Consols were issued by the British Government in 1751 and pay a steady form of interest forever as these bonds do not have a maturity date.
Due to its similarities to an annuity, perpetuity is often recognized as an annuity without an end. Further to this, perpetuity does not have a face value and, therefore, the only payment that will be made by a perpetuity is the interest payments; since interest payments are forever there will be no principal repayment.
Annuity vs Perpetuity
Annuities and perpetuities can be easily confused by many because of their similarities. However, these two forms of financial payments are quite different to each other. Both annuities and perpetuities make payments at regular intervals and similar to each other in that they are both paid as a form of return for an investment made.
There are a number of differences between the two. To begin with, annuities are payments made for a predetermined period of time, and perpetuities are payments made forever. Furthermore, annuities have a face value and the periodic payment that is made to the investor will include a portion of the principal along with interest. Perpetuities, on the other hand, do not have a face value, and since payments are made eternally, the principal of a perpetuity will never be paid.