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Tejas Gaikwad
A financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time. Annuities are primarily used as a means of securing a steady cash flow for an individual during their retirement years.
Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. Annuities can be created so that, upon annuitization, payments will continue so long as either the annuitant or their spouse is alive. Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives.
Annuities can be structured to provide fixed periodic payments to the annuitant or variable payments. The intent of variable annuities is to allow the annuitant to receive greater payments if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for a less stable cash flow than a fixed annuity, but allows the annuitant to reap the benefits of strong returns from their fund's investments.
The different ways in which annuities can be structured provide individuals seeking annuities the flexibility to construct an annuity contract that will best meet their needs.
There are two basic types of annuities:-
a) Deferred Annuities:-
In a deferred annuity, you typically receive payments starting at some future date, usually at retirement. However, most deferred annuities allow for systematic withdrawal payments beginning thirty days after the purchase of your annuity, up to 10% per year, in most cases. With a deferred annuity you can invest either a lump sum all at once, or make periodic payments, either fixed or variable. Those funds grow tax-deferred until you’re ready to begin receiving payments. Deferred annuities make up a large majority of all annuity sales in the United States, and are the type of annuity that Annuity FYI generally recommends if you do not need immediate income from your annuity.
b) Immediate Annuities:-
In an immediate annuity, the investor begins to receive payments immediately upon investing. This is for investors that need immediate income from their annuity. When you purchase an immediate annuity you can choose between payments for a certain period of time (typically five to twenty years - “period certain”), payments for the rest of your life and/or your spouse’s life, or any combination of the two. You can even choose between a fixed payment that doesn’t vary or a variable payment that is based on market performance.
How to Calculate Annuity Payments:-
Steps:-
1. Determine the type of annuity:-
a) Annuities can be fixed or variable. A fixed annuity will have a guaranteed payout, while the variable annuity depends heavily on the performance of its investment.
b) Your annuity could be deferred, which means you can postpone payments from it until a specified time. It could also be an immediate annuity, where your payments begin as soon as you make your first contribution.
2. Select the payout option for your annuity:-
a) The most popular payout option pays the full amount of the annuity over a specified period with any balance after death being paid to the beneficiary.
b) There are other payout options that will either pay the annuity holder or the holder and the remaining spouse for life, as well as payout options that combine 2 or more options.
3. Find the other details of the annuity, including the principle balance and interest rate.
4. Calculate the amount of the payments based on your specific annuity situation:-
a) For example, assume a $500,000 annuity with a 4 percent interest rate that will pay a fixed annual amount over the next 25 years.
b) The manual formula is Annuity Value = Payment Amount x Present Value of an Annuity (PVOA) factor. The a link to the PVOA factor table can be found in the Sources section of this article.
c) The PVOA factor for the above scenario is 15.62208. 500,000 = Payment x 15.62208. Convert the formula to isolate the variable by dividing both sides by 15.62208; Payment = $32,005.98.
d)You can also calculate your payment amount in Excel using the "PMT" function. The syntax is "=PMT(Interest rate,Number of periods, PresentValue, Future Value)." For the above example, type "=PMT(0.04,25,500000,0)" in a cell and press "Enter." There should be no spaces used in the function. Excel returns the value of $32,005.98.
5. Adjust your calculation if your annuity will not begin paying out for several years:-
a) Find the future value of your present principle balance by using the Future Value table (linked in the Sources section), the rate of interest that will accrue on your annuity between now and when it begins to pay out and the number of years until you begin drawing payments.
b) For instance, assume that your $500,000 will earn 2 percent annual interest until it begins paying out in 20 years. Multiply 500,000 by 1.48595 as per the FV factor table to find 742,975.
c) Find the future value in Excel by using the FV function. The syntax is "=FV (Interest Rate, Number Of Periods, Additional Payments, Present Value)." Enter "0" for the additional payments variable.
d)Substitute this future value as your annuity balance and recalculate the payment using the "Annuity Value = Payment Amount x PVOA factor" formula. Given these variables, your annual payment would be $47,559.29.
Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. Annuities can be created so that, upon annuitization, payments will continue so long as either the annuitant or their spouse is alive. Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives.
Annuities can be structured to provide fixed periodic payments to the annuitant or variable payments. The intent of variable annuities is to allow the annuitant to receive greater payments if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for a less stable cash flow than a fixed annuity, but allows the annuitant to reap the benefits of strong returns from their fund's investments.
The different ways in which annuities can be structured provide individuals seeking annuities the flexibility to construct an annuity contract that will best meet their needs.
There are two basic types of annuities:-
a) Deferred Annuities:-
In a deferred annuity, you typically receive payments starting at some future date, usually at retirement. However, most deferred annuities allow for systematic withdrawal payments beginning thirty days after the purchase of your annuity, up to 10% per year, in most cases. With a deferred annuity you can invest either a lump sum all at once, or make periodic payments, either fixed or variable. Those funds grow tax-deferred until you’re ready to begin receiving payments. Deferred annuities make up a large majority of all annuity sales in the United States, and are the type of annuity that Annuity FYI generally recommends if you do not need immediate income from your annuity.
b) Immediate Annuities:-
In an immediate annuity, the investor begins to receive payments immediately upon investing. This is for investors that need immediate income from their annuity. When you purchase an immediate annuity you can choose between payments for a certain period of time (typically five to twenty years - “period certain”), payments for the rest of your life and/or your spouse’s life, or any combination of the two. You can even choose between a fixed payment that doesn’t vary or a variable payment that is based on market performance.
How to Calculate Annuity Payments:-
Steps:-
1. Determine the type of annuity:-
a) Annuities can be fixed or variable. A fixed annuity will have a guaranteed payout, while the variable annuity depends heavily on the performance of its investment.
b) Your annuity could be deferred, which means you can postpone payments from it until a specified time. It could also be an immediate annuity, where your payments begin as soon as you make your first contribution.
2. Select the payout option for your annuity:-
a) The most popular payout option pays the full amount of the annuity over a specified period with any balance after death being paid to the beneficiary.
b) There are other payout options that will either pay the annuity holder or the holder and the remaining spouse for life, as well as payout options that combine 2 or more options.
3. Find the other details of the annuity, including the principle balance and interest rate.
4. Calculate the amount of the payments based on your specific annuity situation:-
a) For example, assume a $500,000 annuity with a 4 percent interest rate that will pay a fixed annual amount over the next 25 years.
b) The manual formula is Annuity Value = Payment Amount x Present Value of an Annuity (PVOA) factor. The a link to the PVOA factor table can be found in the Sources section of this article.
c) The PVOA factor for the above scenario is 15.62208. 500,000 = Payment x 15.62208. Convert the formula to isolate the variable by dividing both sides by 15.62208; Payment = $32,005.98.
d)You can also calculate your payment amount in Excel using the "PMT" function. The syntax is "=PMT(Interest rate,Number of periods, PresentValue, Future Value)." For the above example, type "=PMT(0.04,25,500000,0)" in a cell and press "Enter." There should be no spaces used in the function. Excel returns the value of $32,005.98.
5. Adjust your calculation if your annuity will not begin paying out for several years:-
a) Find the future value of your present principle balance by using the Future Value table (linked in the Sources section), the rate of interest that will accrue on your annuity between now and when it begins to pay out and the number of years until you begin drawing payments.
b) For instance, assume that your $500,000 will earn 2 percent annual interest until it begins paying out in 20 years. Multiply 500,000 by 1.48595 as per the FV factor table to find 742,975.
c) Find the future value in Excel by using the FV function. The syntax is "=FV (Interest Rate, Number Of Periods, Additional Payments, Present Value)." Enter "0" for the additional payments variable.
d)Substitute this future value as your annuity balance and recalculate the payment using the "Annuity Value = Payment Amount x PVOA factor" formula. Given these variables, your annual payment would be $47,559.29.