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Effects Of Annuities With Time Value Money
Annuities refer to a series of fixed payments that are paid to you over a fixed period of time. Annuities are sold by insurance companies and once you make the required principal payment to the insurance company, you get either yearly, semi-annually, quarterly or monthly payments from the insurance company. |
Typically annuities are of two types. These are fixed annuities and variable annuities. We will discuss each type so that you have a better understanding of the effects of annuities with time value of money.
Fixed Annuity
In a fixed annuity you keep receiving your money immaterial what is the outcome of the investment that the insurance company undertakes with the money to give them.
Variable Annuity
In a variable annuity you receive the money based on the performance of your investment options.
If we take time value of money, the concept is very simple. It means that a dollar today is worth more than a dollar tomorrow. In other words, if you have money today you can buy what you really need immediately. Alternatively, you can forgo your current need and wait until later to buy what you need so that you lend your money to another person with the promise of being paid back at some time in the future. And as you are giving up what you need, you would obviously want the other person to return enough money back so that you buy as much as what you need in future based on what you are giving it up presently.
However, this concept can be a risky proposition for you. The borrower may disappear without paying. Or, the borrower might return the money to you but you no longer can purchase what you need because of increase in price. So, you, as a lender, ask a higher rate of interest so that you are compensated for taking the risks.
Time value of money is used to compare investment alternatives and to solve problems involving annuities. The effects of time value of money on annuities is a concept which determines how a single sum of money or series of equal payments promised in the future can be converted to an equivalent value today. This helps to determine the amount of annuity you receive.
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