The amount of money invested in both cases can be the same or different per individual. Having a background in finance makes it difficult for a person to understand the terms used in the financial world.
We all are related to the financial sector, and it becomes necessary for everyone to understand the basic terms of finance.
Key Takeaways
- Annuity is a series of fixed payments made at regular intervals for a specified period of time.
- Perpetuity is a series of fixed payments made at regular intervals indefinitely.
- Annuity has a fixed end date, while perpetuity does not have an end date.
Annuity vs Perpetuity
The difference between Annuity and Perpetuity is that while an annuity continues for a fixed period, a perpetuity continues indefinitely. An annuity is a fixed amount of periodic cash flow for a limited time or a series of fixed amounts paid or received at regular intervals (annually, semi-annually, quarterly, monthly, etc.).
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Perpetuity is a type of annuity that is continuous for an indefinite period. Perpetuity is an infinite series of periodic payments of equal face value.
Let’s understand these two concepts deeply.
Comparison Table
| Parameter of Comparison | Annuity | Perpetuity |
|---|---|---|
| Meaning | An Annuity is a fixed amount paid or received at equal intervals for a specific time. | On the other hand, Perpetuity is an equal payment of an amount for an infinite period. |
| Duration | An annuity is continuous for a fixed time. | While the duration of perpetuity is infinite. |
| Types | There are two types of Annuities- 1. Ordinary Annuity. 2. Annuity due. | Perpetuity doesn’t have any type. |
| Interest used | Compound interest is used for the calculation of the present value or future value of an Annuity. | In the case of Perpetuity, Simple interest is used to calculate the present value. |
| Future value | The Future Value of an Annuity can be calculated by using compound interest. | While the Future Value of a Perpetuity cannot be calculated. |
What is an Annuity?
An Annuity is a series of the same amount of cash flow, paid or received at equal intervals for a predetermined time. An annuity is used for a variety of purposes, but the most common use of an Annuity is for pension payment.
The areas where Annuity is commonly used are EMIs, Life Insurance premiums, etc. Compound interest is used for the calculation of the present value or future value of an Annuity.
Since an Annuity is paid or received on fixed intervals like annually, semi-annually (6 months), quarterly (3 months), monthly, etc., the interest gets compounded as per the fixed period.
An annuity is mainly part of retirement plans and insurance contracts. Annuity generally has a few types, but mainly it has two types-:
- Annuity Due – The annuity payments or receipts must be made or gained at the beginning of the period, e.g. Rent paid in advance.
- Ordinary Annuity – the annuity payments or receipts must be made or gained at the end of each period, e.g. Coupon payments by a financial institution.
What is Perpetuity?
Perpetuity is a type of Annuity that never comes to an end. Perpetuity is also known as ‘Perpetual Annuity’; the word ‘Perpetuity’ is derived by combining these two words, ‘Perpetual + Annuity’. Perpetuity is a series of cash flows paid at regular intervals and for an infinite period.
The best example of Perpetuity is the bonds issued by the British Government in 1751, known as CONSOL, on which the government pays a steady form of interest forever as these bonds do not have a maturity date.
Since Perpetuity is a financial asset, its owner will receive a constant amount forever. Since the period is not fixed, compound interest cannot be used in fields where Perpetuity is concerned.
Also, the Principal is never repaid in the case of Perpetuity. Let’s understand perpetuity with this; when an owner purchases a property and rents it out.
The owner is entitled to an infinite stream of cash flow from the renter as long as the property continues (assuming the renter will rent). Perpetuity does not have types but can be classified as-
- Constant Perpetuity – it is that Perpetuity which remains the same forever.
- Growing Perpetuity – it grows at a uniform rate forever.
Main Differences Between Annuity and Perpetuity
- An annuity is paid or received for a fixed period. On the other hand, Perpetuity is paid for an indefinite time.
- The Future Value of an Annuity can be determined. But the Future Value of a Perpetuity cannot be calculated.
- Compound interest is used in the calculation of the present value of an annuity. Whereas in the case of Perpetuity, compound interest has no use.
- An annuity is a comprehensive concept since perpetuity is a type of Annuity.
- The annuity has more applications than Perpetuity, which has a limited application.
- The payment can be made or received in the case of Annuity, but in Perpetuity, it is only made.
- Life insurance premiums, retirement plans, etc., often include Annuities. While bonds without a maturity date, long terms lease contracts, etc., include the concept of Perpetuity.
- https://digitalcommons.georgefox.edu/cgi/viewcontent.cgi?article=1114&context=gfsb
- https://iabe.org/domains/iabeX/Documents/Proceedings/IABE-2009%20Las%20Vegas-%20Proceedings.pdf#page=105
- https://www.tandfonline.com/doi/abs/10.2469/faj.v56.n2.2345
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
