How to Calculate Annuity Factor?

How to Calculate Annuity Factor for Present Value of Annuity ?

The present value of annuity refers to the current value of future annuity payments to be paid at a specified rate of return, also known as the discount rate. Higher the rate, lower the value of an annuity.

You can calculate the present value annuity factor to find out if you will receive more cash by taking a lump sum payment now or periodic payments spread out over several years.

The formula for how to calculate annuity factor for the present value of an annuity is:

PV = C X [{1-(1+r)^-n }/ r]

Where PV = Present value of an annuity

C = cash flow per period or payment amount

r = interest rate

n = number of periods in which payment will be done

The present value of annuity indicates the funds needed today to fund future annuity payments. This calculation is done under the premise that the sum of money received today is more valuable than the same amount got at a future date.

Benefits of Calculating the Present value of Annuity

Here are the benefits of calculating the present value of an annuity.

• The present value of an annuity is an indicator of the amount to be invested now to get the desired cash flow post-retirement.

• You can find out the annuity payments paid after the accumulation phase.

• The present value of an annuity can be used to assess the amount an individual needs to pay to an immediate annuity plan to obtain a specific annuity amount.

How to Calculate Annuity Factor for Future Value of Annuity?

The future value of annuity refers to the value of a bunch of recurring payments paid out at a specified date in the future at a certain rate of return or a discount rate. The higher the rate, the greater is the value of the future annuity.

The future value annuity factor is calculated to find out how much worth a series of payments will be at a future date.

The formula for how to calculate annuity factor for the future value of an annuity is:

FV = C X [{(1+r)ⁿ  - 1} / r] X (1+r)

Where FV = Future value of annuity

C = cash flow per period or payment amount

r = interest rate

n = number of periods in which payment will be done

Benefits of Calculating the Future Value of Annuity

Here are the benefits of calculating the future value of an annuity.

• The future value of annuity indicates the payments that you will receive at a certain future date from an annuity plan and the worth of the amount.

• The future value of annuity calculation can help you make better financial decisions and plan your funds according to your financial goals and objectives.

What is an Annuity?

An annuity is a financial instrument that makes a fixed stream of payment to any individual. Annuities are mainly utilized as an income source for retired people. Annuities can also be defined as contracts issued and sold by financial institutions that invest funds of their clients. They help the investors maintain a regular stream of savings throughout their lifetime.

The time period between the date when the annuity is funded till the date the payouts are made is called the accumulation phase. Once the payouts begin, the annuity contract enters the annuitization phase. During the accumulation phase, investors can find the product through a lump sum amount or periodic payments. Once the annuitization period commences, the product pays to the annuitant either a single fixed amount or periodically for their remaining lifetime. Annuities can be either fixed or variable instruments offering immediate or deferred income, thereby offering flexibility to the annuitants.

Annuities are a reliable way to guarantee steady cash flow for individuals post their retirement and reduce fears of outliving one’s assets and savings. Through annuities, one can convert a substantial amount such as a jackpot win or huge cash settlements into steady cash flow. Some examples of annuities are defined pension amounts and social security as they pay out retirees a steady amount until their death.  

Types of Annuities

1. Lump-Sum and Periodic Annuities

   Types of annuities depend upon many factors and details such as the duration of payments that the annuity can continue to make. Annuities can be structured in 2 ways – One where payments will continue periodically until the annuitant or their spouse is alive and the other where funds are paid out in lump sum for a fixed time period (say 20 years) irrespective of how long the annuitant is alive.   

2. Immediate and Deferred Annuities

   The other classification of annuities is immediate and deferred annuities. They can either begin immediately upon deposit of a lump sum amount or they can offer deferred benefits. In immediate payment annuity, payments begin immediately after a lump sum payment. In a deferred income annuity, payouts do not begin right after the initial investment. Instead, the annuitant specifies the age when they would prefer to receive payments from the financial institution.

3. Fixed and Variable Annuities

   Annuities can also be structured as fixed and variable annuities. Fixed annuities provide fixed period payouts to the annuitant. Variable annuities allow the annuitant to receive higher cash flows in the future if the annuity investments perform well and lower cash flows in case the investments perform poorly. Variable annuities offer less stable cash flow than fixed annuities but allow the annuitant to reap the benefits of high returns from the invested funds.

   Variable annuities carry a slight risk of losing the principal of investment, certain features and riders can be added to them that let them function as fixed variable annuities. The annuitants can enjoy the benefit of the upside potential of the portfolio along with the lifetime guaranteed minimum withdrawal facility in case the value of the portfolio drops.

The Bottom Point!

Before you figure out how to calculate annuity factor for the present or future value of annuities, you must understand whether the annuity is an Ordinary annuity (payments made at the end of every period), or Annuities Due (payments made at the beginning of every period). Then you can use the formulas mentioned above to calculate the annuity factors to accurately determine the present or future value of an annuity.