Annuity vs. Perpetuity

While all perpetuities are annuities, not all annuities are perpetuities.

An annuity is a financial contract between an individual — the contract owner — and an insurance company — the issuer. In exchange for an upfront payment or a set of installment payments, the insurance company provides a named annuitant, usually the contract owner, a series of income distributions.

The distributions can be immediate or deferred and variable or fixed, depending on the nature of the contract. Regardless, the frequency of the payments is fixed, and they end at a specified point in time. Generally, the expiration date is defined as a certain number of years or the lifetime of the annuitant.

With a perpetuity, the duration of the income distributions is indefinite. In other words, they continue forever — into perpetuity, which is the origin of the instrument’s name.

The critical difference between an annuity and a perpetuity is the length of time income distributions are provided. As noted above, an annuity has a definite payout expiration date, while a perpetuity makes payouts indefinitely.

Another notable difference relates to their availability. There are many different types of annuities, with a range of features designed to meet the diverse needs of investors, especially retirees. At the highest level, they are categorized as either fixed, fixed indexed or variable.

Fixed annuities are the safest and most predictable, but they are relatively low-yielding. Fixed indexed annuities offer more upside potential, while providing a guaranteed minimum rate of return. Variable annuities offer the highest return potential, but they are exposed to downside risk.

Unlike annuities, perpetuities are extremely rare. In fact, it is difficult to pinpoint a single insurance company that currently markets such products. Today, the perpetuity vehicle appears to be merely a theoretical concept.

A 55-year-old man buys a deferred fixed indexed annuity as part of his retirement plan. The contract, which names him as the annuitant, specifies a 10-year accumulation period to allow the initial investment to grow and monthly income distributions for life. When the man reaches 65 years old, the monthly payments will begin and continue until he dies.

A 55-year-old man buys an immediate perpetuity with semiannual payments. The contract, which names him as the payment recipient, specifies fixed distributions to be made each Jan. 1 and July 1 forever, assuming the issuing insurance company continues to exist. When the man dies, his heirs will inherit the perpetuity contract and collect the payments.

An annuity is ideal for a person who needs to ensure he or she has a consistent stream of income for a finite amount of time, such as the period between retirement and death. In this scenario, it can be a highly effective way to mitigate longevity risk, which is the danger of outliving your savings.

A perpetuity would be a good choice for a person who wants to leave an income stream to a loved one or charitable organization after death. However, as noted previously, it is difficult to purchase a perpetuity because no insurance companies currently sell them.

That said, there are two investment vehicles that approximate a perpetuity: a perpetual bond and a preferred stock. The former, which is a debt security, offers a coupon payment that continues forever, assuming the issuing entity remains solvent. The latter, which is an equity security, offers a perpetual dividend payment, subject to the discretion and financial well-being of the issuing entity.

Neither an annuity nor a perpetuity is inherently a good or bad investment. Either can be sensible depending on your individual circumstances. If you need help determining whether one is right for you, consider consulting with a fiduciary financial advisor.