Annuity vs. Perpetuity: Can Annuities Be Perpetual?
Annuities pay for a defined period or a lifetime. Perpetuities pay forever. Understanding this distinction matters for retirement planning — because almost all annuity products available today are not perpetuities, and true perpetuities are extremely rare financial instruments.
What Each Term Actually Means
Many new investors seek to understand annuities by comparing them to more familiar investment terms. Here is a clear definition of both — and how they differ.
Payments for a Defined Term
In general, the term “annuity” refers to an investment product sold by insurance companies. These investments are offered in fixed or variable options. Fixed options pay a guaranteed minimum, while variable options are backed by a chosen investment portfolio and pay out based upon the performance of that portfolio.
Traditional annuities are designed to make payouts over a specified and limited amount of time. These payouts may last for 10 years, 20 years, a lifetime, or any other term agreed upon by the investor and the insurance company. By its general definition, an annuity is “a fixed sum of money paid to someone each year.” Most annuity products eventually expire and stop paying out.
A 67-year-old purchases a lifetime fixed annuity. Payments continue each month until they die. After death, payments cease — unless a joint-life or period-certain rider is attached.
Payments That Never End
A perpetuity can take form as several different types of investments. The word itself derives from the Latin adjective “perpetuus”, which means continuous or uninterrupted. In other words, a perpetuity is a bond or other type of security that has no fixed maturity date. Payouts never end, because by definition, perpetuities make payouts forever.
An example of a perpetuity in bond form is the UK’s government bond — known as a “Consol.” By purchasing a Consol, bondholders are guaranteed an interest payment on an annual basis for as long as they hold the bond, and as long as the Consol is not discontinued by the government.
A UK government Consol bond pays £50 per year indefinitely. The bondholder can sell the bond to another party, who then receives the same £50 per year in perpetuity.
Can an Annuity Be Perpetual?
There is only one difference between a traditional annuity and a perpetuity — an annuity pays for a set number of years (or for a lifetime) while a perpetuity pays an income indefinitely. This means that all perpetuities are annuities by definition, but not all — and not many — annuities are perpetuities.
In theory, an annuity can be a perpetuity depending on how it is designed. If it is structured so that payments last forever, even after the investor’s lifetime, then it is considered a perpetual annuity. Traditional and perpetual annuities are both types of annuities, but they are differentiated from each other based on the duration of their payments.
Here’s the catch: perpetual annuities, bonds, and other investments are extremely rare. The few that have existed in the past generally also included specific conditions that allowed for ending the perpetuity and exiting the agreement. No one — including insurance companies and governments — wants to be responsible for owing someone until the end of time. Although it is unlikely that you will ever come across a true annuity that pays out for an indefinite term, there are many annuity options that will pay out long enough to meet the terms of any long-term financial plan.
Many annuity options carry a lifetime payout, and some even carry a death benefit that can be transferred to a beneficiary at the end of the investor’s life. These are the practical equivalent of a perpetuity for most planning purposes.
- All perpetuities are annuities by definition, but very few annuities are perpetuities
- Lifetime annuities pay until death — not indefinitely
- A perpetuity’s present value is calculated as: Annual Payment ÷ Discount Rate
- True perpetuities are extremely rare and mostly theoretical
- A death benefit rider on a lifetime annuity can approximate perpetuity-like income continuity for heirs
- For retirement planning purposes, a lifetime annuity solves the same problem a perpetuity would
How Present Value Is Calculated
Since one option has a defined ending term and the other has no defined term, there is a major difference in how present value is calculated for each type of investment.
The “present value of an annuity formula” allows investors to determine the current value of future periodic payments. Since there is a defined ending term, the formula depends on three factors: the amount of payment per period, the rate of interest per period, and the total number of periods in which the payment will be made.
Where: P = payment per period, i = interest rate per period, n = number of periods
For example, where $500 is paid at the end of each month for an entire year with an annual interest rate of 12% (monthly rate = 1%), the present value would equal $5,627.54 at the beginning of the term.
Although a perpetuity may promise to pay you forever, it does not maintain its value indefinitely. Most of the value of a perpetuity is earned in the near future rather than in the long term. Since there is no defined end date, the formula for calculating a perpetuity’s present value depends only on the annual payout and a discount rate defined by the investor.
Where: the discount rate reflects the investor’s required return
If a perpetual bond pays $1,000 per year and a 5% return is deemed suitable, the present value = $1,000 ÷ 0.05 = $20,000. At a 3% discount rate, the same payment has a present value of $33,333. Present value of a perpetuity increases as the discount rate decreases.
Frequently Asked Questions
1 What is the difference between an annuity and a perpetuity? ▼
2 Do any annuities pay out forever? ▼
3 Is a lifetime annuity the closest thing to a perpetuity for retirement planning? ▼
4 How is the present value of a perpetuity calculated? ▼
5 Are there real-world examples of perpetuities? ▼
6 Can an annuity death benefit extend payments like a perpetuity? ▼
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