Annuities & Perpetuities

Annuities & Perpetuities

The time value of money is present in all aspects of business impacting government, business, and consumer finance. Annuities and perpetuities are two financial concepts used as a type of a payment schedule in business. They are each structured in their own ways and are not for everyone. Some investors prefer one over the other depending upon the time value of money and the outcome they will receive. "Annuities and perpetuities are both a series of structured payments," however, "an annuity lasts for a fixed period of time whereas a perpetuity continues on forever" (Golden, 2009).

A loan is a good example of an annuity. Loans are generally set up for a lender to receive a certain amount of money for a certain amount of time with a certain interest rate. As we can see from this example, an annuity has a limited timeframe or lifespan with a pre-determined face value and a specified interest rate. These can be structured in many different ways depending upon the investors and the details such as durations or length of time, the number of payments and whether these payments are fixed or variable, and by life expectancy. They can be structured towards the preference of the investors.

A perpetuity is just the opposite of an annuity. An example of a perpetuity would be renting out a house. The landlord rents out a house to a renter for a specified amount of money with a renters agreement which for a certain amount of time or with an infinite amount of time. The renter pays the landlord rent which is an additional source of income for the landlord. This amount of rent could stay the same or change over a period of time because there are no pre-determined rates. For example, I paid a certain amount of rent until a certain period in time when the landlord increased it due to economical reasons. Perpetuities have no set timeframes and no face value and are structured with flexibility much like that of a perpetual bond that can have a variable or floating rate of interest creating fluctuating payments. Perpetuities are, however, very rare these because not many people want to spend the rest of their lives making payments.

Depending upon the investors, they may prefer one over the other. Time value of money can have an effect on the investor's preference in deciding which will offer the better rate of return or better rate of interest meaning that the investor feels that the time value of money is evident in one more than the other. Also, the time value of money can "impact the eventual returns of" (CTU Online, 2012) annuities and perpetuities due to the terms or length of payments. The longer it takes to pay off a loan, the more interest is paid, creating a loss for the investor. This is another reason for preference.

When structuring an annuity or perpetuity, it is important to keep in mind the life expectancy. For example, if an