Floating annuity

An annuity pays a sum of money at regular intervals — monthly, quarterly or yearly. A pension is the everyday example.

Not every annuity pays the same amount each time. A floating annuity is the kind that does not. Its payout is benchmarked to something that moves — inflation, a market index, or another return agreed when the investment was made.

A fixed annuity is the opposite: it pays the same amount every period, agreed in advance. The workbook actually introduces this pair under two different names in two places — first calling floating annuities 'flexible annuities', then 'floating annuities' three sentences later. Both names point at the same idea.

The workbook's definition: floating annuities are those in which the returns are benchmarked to inflation, an index, or any other return specified in the agreement at the time of buying — so the amount paid changes as that benchmark moves, rather than staying fixed at a set rate like the 5.5% the workbook uses for its fixed annuity example.

The benchmark itself is fixed at the outset, even though the payout is not. An investor buying a floating annuity linked to inflation knows the rule — track inflation — from day one; only the rupee amount each period changes as the rule plays out.

Illustrative, since the workbook gives the mechanism without a worked payout. Mrs Rao buys a floating annuity of Rs 20,00,000, benchmarked to CPI inflation, instead of a fixed annuity paying a flat 5.5% every year.

In a year when inflation runs at 7%, her annuity pays close to Rs 1,40,000 for that year. In a calmer year when inflation is only 4%, the same annuity pays roughly Rs 80,000 instead. A holder of the fixed annuity earning 5.5% would have received exactly Rs 1,10,000 in both years — more than Mrs Rao in the calm year, less than her in the high-inflation year. Neither annuity is simply 'better'; they trade certainty for a chance of keeping pace with rising prices.

Chapter 2 (Time Value of Money), section 2.2.6 (Annuity), introduces floating annuities right after fixed annuities, using the same fixed deposit contrast. Expect a question distinguishing fixed from floating annuities, or one testing whether a candidate recognises an inflation-linked or index-linked payout as a floating annuity.

• The workbook names this type inconsistently — 'flexible annuity' when the two types are first listed, then 'floating annuity' in the very next paragraph. Both refer to the same thing; do not treat them as different products.
• Floating does not mean uncertain in every sense. The benchmark and the rule for tracking it are fixed at the time of purchase — only the resulting rupee payout moves.
• Do not confuse this with ordinary versus annuity due, which is about when in the period the payout falls, not whether the amount is fixed or floating — the two classifications are independent.