Annuity Certain

An annuity certain, or ordinary annuity is an investment that makes guaranteed payments to a person for a specific period. The main purpose of this annuity is that people receive fixed and periodic payments for a pre-determined time duration called annuity period.

Ordinary annuity certain is a good investment option for retirees. It helps to get a fixed lump sum amount on retirement. Thus the annuitant can use it as a means of passive income stream. However, despite being alive, they will not receive any amount after the time expires.

• An annuity certain is an investment product that gives guaranteed payments to the person till maturity. Most individuals choosing to retire go for this annuity option. 
• As defined by Sir Edward Coke, the two main types of annuity are ordinary and contingent annuity certain. 
• In annuity certain, the payments occur at the end of the period for 10, 15, or 20 years. So, for example, a retiree can receive money every quarter.
• The nominees (spouse or children) receive the rest if the annuitant dies. But, if the period expires, they will receive no amount. 

Annuity certain is similar to a retirement plan that gives guaranteed payments to retirees. It is a regular payment system paid on maturity. However, it pays the amount for a specific period alone. So, the individual cannot access the amount if the time expires or passes by. Likewise, the broker will transfer the benefits to the nominees in case of the early death of the individual.

The history of the annuity certain travels back to the mid-17th century. In the 1620s, an Attorney Judge of England, Sir Edward Coke, defined this concept and its types. According to Coke, there are two types of annuity- ordinary and contingent annuity certain. The payments occur at equal intervals for a specific time in an ordinary annuity.

An insurer can make these payments monthly, quarterly, semi-annually, or annually. However, the interest gets compounded till collection if the person does not collect the outstanding payments. A contingent annuity, on the other hand, as the name suggests, is contingent on the nature of current payments.

The annuity certain period is typically 10, 15, or 20 years. The future value of this annuity depends on the last cash flow amount. Individuals can use this amount for various purposes, including automobile financing, housing, or paying credit card dues. So if the annuitant fails to make payments, the lender will stop the outstanding dues and declare it debt paid.

The annuity certain formula is as follows:

Annuity certain = r * P / {1 – (1+r)-(n-1)}

where  r - Interest rate of the annuity

            P - Payment made to the annuitant

            n - Number of payments in that period

Individuals use this formula to calculate the present value of the investment at the period's beginning and end. For example, if a person is eligible for Social Security benefits, the annuity certain formula will help them to understand the payment received at maturity.

However, this amount is better for a short-term period due to mortality issues. For example, if a person retires at 65, he will receive an amount comparatively greater than the one they receive if they choose a long payment period and dies at 68.

Let us now look at an example to understand the concept better:

In addition, he needs to nominate a beneficiary or nominee who will receive the rest. After retirement, he receives a quarterly payment of $600. Unfortunately, by age 67, he dies, and the kids receive the benefits. Thus, for the remaining 15 years, the beneficiaries receive the amount.

Suppose John Fred is a government employee working in the United States. He joined the military force in 1978 and chose to retire at 62. Before that, he had invested some money in a certain plan to give him a premium plus amount on retirement. The plan informs the insurer to make equal payments to Fred from retirement to another 20 years.

Annuity certain is a perfect option for individuals retiring at the age of 64 or more. As it is the best investment option for them, it can yield good returns and a premium. In addition, many financial institutions deliver good annuity plans. Also, an annuitant does not have to pay taxes until withdrawal. However, once withdrawn, it will attract a certain tax percentage. But there are also some disadvantages too.

In case the period expires, the annuitant cannot access the amount although they are alive. Likewise, it is only suitable for a short-term period as the mortality (death) rate has decreased in past decades.

Although Coke described annuity certain and annuity due as annuities, they have a huge difference. After retirement, employees and individuals who wish to earn passive income mostly use the former. In contrast, annuity due is a similar investment plan where the insurer pays the annuitant at the beginning of the year. So, for example, if a person buys an annuity-due plan, they will receive the amount on October 1 rather than October 31. 

However, it differs from the ordinary annuity, where the annuitant receives an amount at the end of the period. As a result, individuals use this money to make timely payments due in the beginning. For example, using annuity due amounts to make rental payments to landlords. 

This has been a guide to what is Annuity Certain. Here, we explain its formula, example, pros & cons, and comparison with an annuity due. You can learn more about financing from the following articles –

• Annuity Factor
• Tax-Sheltered Annuity
• Present Value of an Annuity Formula