TaxDose com. Toggle navigation. Author Recent Posts. Swaraj Goyal. Professional Tax Consultant and Article Writer. Latest posts by Swaraj Goyal see all. The below are different types of fixed annuities. The amount of income varies in this type of annuities since they give the opportunity for investors to generate higher rates of return by investing in equity or bond sub accounts. Income will vary based on the performance of the sub account values.
This is ideal for investors who wish to benefit from higher returns, but at the same time, they should be prepared to endure the probable risks. Variable annuities have higher fees due to the associated risk.
This is an investment maintained by making periodic deposits. Similar to annuity, sinking funds also calculate interest on compound basis. However, unlike annuity, interest will be earned on the sinking fund. The interest for February will be calculated for 11 months assuming that this is a one-year sinking fund. It is important for an investor to know what is the total sum that the fund will have at its maturity; this can be derived using the following formula.
The difference between Annuity and Sinking Fund is their investment requirement; Sinking Fund does not require a lump sum of money at the beginning of the investment, making it an attractive investment option for many investors.
Investing in an annuity is usually done by a person closer to retirement in order to receive a guaranteed income during retirement. However, if the stock market conditions are not favorable, the investments in variable annuities will generate more volatile returns. Reference: 1. If the bonds issued are callable , it means the company can retire or pay off a portion of the bonds early using the sinking fund when it makes financial sense.
The bonds are embedded with a call option giving the issuer the right to "call" or buy back the bonds. The prospectus of the bond issue can provide details of the callable feature including the timing in which the bonds can be called, specific price levels, as well as the number of bonds that are callable. Typically, only a portion of the bonds issued are callable, and the callable bonds are chosen by random using their serial numbers. A callable is typically called at an amount slightly above par value and those called earlier have a higher call value.
If interest rates decline after the bond's issue, the company can issue new debt at a lower interest rate than the callable bond. The company uses the proceeds from the second issue to pay off the callable bonds by exercising the call feature.
As a result, the company has refinanced its debt by paying off the higher-yielding callable bonds with the newly-issued debt at a lower interest rate. Also, if interest rates decrease, which would result in higher bond prices, the face value of the bonds would be lower than current market prices. In this case, the bonds could be called by the company who redeems the bonds from investors at face value.
The investors would lose some of their interest payments, resulting in less long-term income. Sinking funds may be used to buy back preferred stock. Preferred stock usually pays a more attractive dividend than common equity shares. A company could set aside cash deposits to be used as a sinking fund to retire preferred stock. In some cases, the stock can have a call option attached to it, meaning the company has the right to repurchase the stock at a predetermined price.
A sinking fund is typically listed as a noncurrent asset —or long-term asset—on a company's balance sheet and is often included in the listing for long-term investments or other investments.
Companies that are capital intensive usually issue long-term bonds to fund purchases of new plant and equipment. Oil and gas companies are capital intensive because they require a significant amount of capital or money to fund long-term operations such as oil rigs and drilling equipment. Let's say for example that ExxonMobil Corp. Interest payments were to be paid semiannually to bondholders. The company would have also had to pay five years of interest payments on all of the debt.
If economic conditions had deteriorated or the price of oil collapsed, Exxon might have had a cash shortfall due to lower revenues and not been able to meet its debt payment. Paying the debt early via a sinking fund saves a company interest expense and prevents the company from being put in financial difficulties in the long-term if economic or financial conditions worsen. Also, the sinking fund allows ExxonMobil the option to borrow more money if needed. In our example above, let's say by year three, the company needed to issue another bond for additional capital.
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