Get to know Annuity: Definition, Types, Formulas, and Examples

Get to know Annuity: Definition, Types, Formulas, and Examples

Get to know Annuity: Definition, Types, Formulas, and Examples
Get to know Annuity: Definition, Types, Formulas, and Examples

Would you like to shop on credit? Let’s learn about pensions first!

In the banking world, an annuity is actually a term with two definitions, namely as a credit product and as a form of interest. However, an annuity literally has the same meaning, namely: fixed installments of a certain amount, with or without interest. But what exactly is an annuity? How is annuity interest calculated? OCBC NISP has the full discussion below.

What is annuity?

As a banking product, an annuity is a payment made by a customer in a nominal amount at a fixed rate of interest. As a credit component, on the other hand, the annuity interest is a combination of flat and effective interest.

The purpose of an annuity is to ensure transaction security on the part of both the bank and the customer. Because in practice, annuities take a “middle way” to balance the positions of creditors and debtors.

For example, the flat interest rate is considered consumer-friendly, while the effective interest rate is more bank-friendly. The annuity interest option is chosen as a middle ground between the two types of interest.

types of annuities
After discussing what an annuity is, this time we will discuss different types of annuities based on the time of payment. The types of annuities are as follows.

Ordinary pension
An ordinary annuity, also known as a simple annuity, is the most commonly used form of annuity in the banking world. In this concept, an annuity is something that is paid once the loan/investment is completed.

Maturity pension
The next type of annuity is the annuity due. Unlike a simple annuity, you can never withdraw any money or interest on an annuity. Once the banking deal is agreed, you cannot receive the annuity payment before the time of the agreement.

deferred pension
The third type of annuity is a deferred annuity, which is a combination of an ordinary annuity and an annuity due. The payment of a deferred annuity has a short duration. In a year, deferred pensions can be paid out 2-4 times.

direct pension
The last type of annuity is direct annuity, i.e. an annuity with regular payments of a certain amount. Just like an ordinary annuity, this type of annuity is also very common in Indonesia, especially in the credit world.

Formula & calculation of annuity interest

Now that we’ve discussed what an annuity is and what types it has, this time we’ll invite OCBC NISP friends to learn how annuity interest is calculated. The pension formula is as follows:

Annuity Rate = Current Value / {[1 – (1/(1+ Interest) Period)] / Interest Rate}

To better understand the above annuity formula, we provide below a simulation of annuity interest calculation.

example case:

Kevin applied for a car lease loan of IDR 300 million for 5 years. The leasing party uses an annuity calculation system with an interest rate of 1%. So the amount of annuity interest Kevin has to pay is:

interest rate =
= Rp300,000,000 / {[1 – (1/(1+0.01)5)] / 0.01}
= Rp300,000,000 / [(1 – 0.95/0.01]
= IDR 300,000,000 / (0.05/0.01)
= IDR 300,000,000 / 5
= IDR 60,000,000

So the total pension including interest for Kevin’s car loan payments is IDR 360,000,000, with payments of IDR 6 million/month for 5 years.

Example of implementing annuities in the banking world

Having discussed what an annuity is, the annuity interest formula and how to calculate it, this time we will discuss examples of how an annuity is applied in everyday life, namely:

deposit savings
The first example of an annuity being used is a savings deposit. Typically, deposit withdrawals are automatically processed by the bank once you register as a depositor. Aside from the automatic withdrawal, the amount of withdrawn funds is also generally the same in each period and can only be withdrawn every few months. For this reason, the fixed-term deposit balance is included in the term annuity product.

lease loan
Credit leasing is one of the easiest to understand examples of implementing an annuity. After purchasing a vehicle on lease credit, you will usually be asked to agree on a new price, which is the sum of the original price and the annuity. Then the new price (including the annuity) is divided into nominal payments according to the agreed time.

insurance bills
The next example of an annuity application is an insurance bill. If you register as an insurance customer, you will have to pay an annuity every month. However, you cannot withdraw the insurance premium outside of the agreed time. Therefore, insurance is included in the type of deferred annuity.

Contributions to the pension fund
Contributions to pension funds, like insurance, are deferred annuities with monthly payment obligations on the part of the customer. However, you can only withdraw these funds when it is time for your retirement/employment to end suddenly, as required by law.

The final example of an annuity implementation is an investment, and according to the OCBC NISP, this is the easiest example for you to understand. For example, you invest Rp. 50 million in an instrument. After a year, the money has increased to IDR 56.5 million. This money with an increase of IDR 6.5 million is called ordinary annuity because you can withdraw it at any time.

This is an explanation of annuities, types, annuity interest formulas and examples of use. The pension is a bank product that cannot be separated from everyday life, whether it is with or without interest. As a user of banking products, there is nothing wrong with OCBC NISP friends learning about it.

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