Annuity

From Financial Literacy Wiki

Annuity (also known as a single-payment annuity) is a financial instrument that allows for a seller (issuer), typically a financial institution such as a life insurance company, to provide a series of future payments to a buyer (annuitant) for a known sum with a net present value; the payment stream has an unknown duration based principally upon the life expectancy of the annuitant. Generally, such an instrument stops payment at the death of the annuitant. However, it is possible to structure such a contract so that the payments stop upon the death of the second of two annuitants (i.e., a joint and survivor annuity), sometimes with a reduction in the amount of the payment going forward.

The pure life annuity can have harsh consequences for the annuitant who dies before recovering his or her investment in the instrument. Such a situation, called a forfeiture, can be remedied by the addition of a period-certain feature under which the annuity issuer is required to make annuity payments for at least a certain number of years; if the annuitant outlives the specified period certain, annuity payments continue until the annnuitant's death, and if the annnuitant dies before the expiration of the period certain, the annuitant's estate or beneficiary is entitled to the remaining payments certain. The tradeoff between the pure life annuity and the life-with-period-certain annuity is that the annuity payment for the latter is smaller.