What is annuity insurance? Simply put, annuity insurance guarantees that you will receive a fixed rate of interest in the future, irrespective of what the market might be doing at any one time. This allows you to secure your retirement income without having to rely on any external funds. However, what exactly is annuity insurance, and how does it work?

Essentially, annuity insurance works by paying out a fixed amount of money (the annuity) over varying periods of time. The most commonly used periods are thirty years, but some prefer to guarantee a smaller period (e.g., five years) for a fixed payment value. Regardless of the length of the guaranteed period, the annuitant (you) will get a fixed rate of interest (the initial interest rate) irrespective of the market situation. In essence, annuitants are buying insurance that will guarantee a certain rate of interest no matter what happens to the market.

There are two key terms you must understand and appreciate when you are considering annuity plans. First, annuity amortization is the process by which payments are made over time. Essentially, this is how you get the most out of your annuity: as your money is paid out, your principal balance will reduce (or remain flat) due to compound interest. On other words, your payments are compounded over time, meaning the amount you actually invest will grow cumulatively. Next, there is the payment value of the annuity; this is how much your payments are going to be each month. Again, this is how to best use the amount you have invested.

How are annuities determined? Basically, they are simply a contract where the annuitant and the insurance company agree on how the payments are to be structured, how the annuitant’s investment is to be invested, and when those payments are going to occur. The following are the most common methods of calculation used: monthly average of the total amount of payments over the years (APV); the present value (PV) of the annuity over the years; or the cost of investing in a standard amortization plan over the years. All three represent ‘amortized’ payouts, where the payments are made out over the years in a straight line.

Now, you may be wondering why it is important to calculate the present value. Well, most people simply don’t bother because the answer will usually be simple and obvious: the present value will always equal the cost of a regular annuity over the years. But there are times when the present value may not be equal to the cost of investments over time, and when that is the case, you need to calculate PV. Basically, this is a type of loan where the annuitant gets a lump sum and is then expected to pay regular payments for the remaining period of time until the annuity ends. Although this type of loan is different than the usual type of loan, they do have the same potential pitfalls.

There are also other formulas for annuities, one of which is referred to as a CAGree. Basically, these formulas attempt to keep things simple by following a single payment amount over time. It is worth noting that all of these methods have their own merits and drawbacks, so it is crucial to understand them in full before choosing the right method for you. Using the payment amount and the interest rate as a guide, you should be able to choose a payment method that will work best for you.