Understanding Annuities

An annuity is an accumulation of lump sum money that amounts by a series of equal and regular payments

. The reverse process is also possible that is the liquidation of the whole lump sum amount through a series of equal and regular payments. Know -how of total money you need to convert the lump sum to two a series of monthly payment or income such that the particular creation facilitates a flow of monthly retirement income always helps.

A mathematical calculation is involved in processing of this income and in order to understand this, one should have a thorough know-how of simple and compound interest. The process also involves the interaction of time, value and interest rate.

To understand the mathematics involved in the calculation, one should understand the basics of simple and compound interest. The process involves the dealing with the value, time and the interest rate. For example, if a person is contributing hundred dollars over the time of five years and gets an interest rate of 5%, it will value $6800 compounded monthly. The calculation will be done as follows:

FV = PMT[(1 + i)n-1] /I where,

FV = future value.

PMT = total periodic payment

n = compounding period

i = interest rate

Thus, FV = 100(1.004167)60 -1 .004167

FV = 6,800.68

The second situation is converting the lump sum into an annuity payout. In this case the lump sum money has to be converted into equal number of payments over the time. This way the lump sum may decrease in its value but it will still cater to an income of un-proportionate amounts. This kind of annuity is highly favored as supports monthly retirement income.

There is no doubt that Annuities are complex insurance products and investments. Knowledge of the type of annuities that you intend to buy and how the amount that you get will be calculated makes a big difference. The money that you received for from Annuities is very important for the period of your life out of retirement and therefore a lot of caution should be exercised while purchasing one. Safe and thought-over investments in Annuities can lead to a happy future.

by: Brian Sibet

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