John Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.
John Egan Personal Finance ExpertJohn Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.
Written By John Egan Personal Finance ExpertJohn Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.
John Egan Personal Finance ExpertJohn Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.
Personal Finance Expert Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Updated: Jan 24, 2023, 11:54am
Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations.
Getty
When planning for retirement, you need to account for the value of any annuities that you own. Trouble is, there’s not just one value of an annuity—there are two: present value and future value.
An annuity is a contract between you and an insurance company that’s typically designed to provide retirement income. You buy an annuity either with a single payment or a series of payments, and you receive a lump-sum payout shortly after purchasing the annuity or a series of payouts over time.
An annuity’s value is the sum of money you’ll need to invest in the present to provide income payments down the road.
FEATURED PARTNER OFFERDiscover and Compare the Best Annuity Options.
We specialize in helping you compare rates and terms for various types of annuities from all major companies.
Find Out How Much Income an Annuity Can Generate for You.
See how different annuity choices can translate into stable, long-term income for your retirement years.
Schedule Unlimited Free Consultations
Connect with our experts for a comprehensive range of annuity options and guidance.
On Leverage's WebsiteWe specialize in helping you compare rates and terms for various types of annuities from all major companies.
See how different annuity choices can translate into stable, long-term income for your retirement years.
Connect with our experts for a comprehensive range of annuity options and guidance.
Using the present value formula helps you determine how much cash you must earmark for an annuity to reach your goal of how much money you’ll receive in retirement.
If your annuity promises you a $50,000 lump sum payment in the future, then the present value would be that $50,000 minus the proposed rate of return on your money.
As you might imagine, the future value of an annuity refers to the value of your investment in the future, perhaps 10 years from today, based on your regular payments and the projected growth rate of your money.
The present value of an annuity is the total value of all of future annuity payments. A key factor in determining the present value of an annuity is the discount rate. This can be an expected return on investment or a current interest rate.
A lower discount rate results in a higher present value, while a higher discount rate results in a lower present value.
A number of online calculators can compute present value for your annuity. But if you want to figure out present value the old-fashioned way, you can rely on a mathematical formula (with the help of a spreadsheet if you’re comfortable using one). Or you can use an annuity table.
The information you’ll need to calculate present value of an annuity includes:
Because there are two types of annuities (ordinary annuity and annuity due), there are two ways to calculate present value.
Here are the key components of the formula:
Here’s how the formula looks if you’re applying it to an ordinary annuity (also called a deferred annuity):
P = PMT [(1 – [1 / (1 + r)^n]) / r]
Jack is expecting $7,500 for 20 periods from an ordinary annuity with an interest rate of 6%. In Jack’s situation, he’d use this formula:
P = 7,500 [(1 -[1 / (1 + .06)^20]) / .06]
After Jack does the math, he’d come up with a present value of $86,024.41.
The formula looks slightly different if you’re applying it to an annuity due:
P = (PMT [(1 – [1 / (1 + r)^n]) / r]) x (1 + r)
Jill is expecting $7,500 for 20 periods in an annuity due with an interest rate of 6%. In Jill’s situation, she’d use this formula:
P = (7,500 [(1 – [1 / (1 + .06)^20]) / .06]) x (1 + .06)
After Jill does the math, she’d come up with a present value of $91,185.87.
Something to keep in mind when determining an annuity’s present value is a concept called “time value of money.” With this concept, a sum of money is worth more now than in the future.
This has to do with how inflation chips away at value. Due to inflation, $1,000 today is worth more than what that same $1,000 will be worth in 10 years.
“Essentially, a sum of money’s value depends on how long you must wait to use it; the sooner you can use it, the more valuable it is,” Harvard Business School says.
Since an annuity’s present value depends on how much money you expect to receive in the future, you should keep the time value of money in mind when calculating the present value of your annuity.
FEATURED PARTNER OFFERAccess to thousands of financial advisors.
Match with a pre-screened financial advisor that is right for you.
Connect with your match for a free, no-obligation call.
On Datalign Advisory's WebsiteThe future value of an annuity refers to how much money you’ll get in the future based on the rate of return, or discount rate.
The effect of the discount rate on the future value of an annuity is the opposite of how it works with the present value. With future value, the value goes up as the discount rate (interest rate) goes up.
An annuity’s future value is also affected by the concept of “time value of money.” Due to inflation, the $500 you expect to receive in 10 years will have less buying power than that same $500 would have today.
As with the present value of an annuity, you can calculate the future value of an annuity by turning to an online calculator, formula, spreadsheet or annuity table.
You’ll need this information:
The key components of the formula are:
Here’s how the formula looks if you’re applying it to an ordinary annuity (also called a deferred annuity):
FV ordinary = PMT x [ ([1 + r]^n – 1) / r]
Jack expects 30 quarterly payouts of $500 each on an ordinary annuity with an annual interest rate of 6%. In Jack’s situation, he’d use this formula:
FV ordinary = 500 x [ ([1 + .06]^30 – 1) / 0.6]
After Jack does the math, he’d come up with a future value of $39,529.09.
The formula looks a little different if you’re applying it to an annuity due:
FV due = PMT x [ ([1 + r]^n – 1) x (1 + r) / r]
Jill expects 30 quarterly payouts of $500 each on an annuity due with an annual interest rate of 6%. In Jill’s situation, she’d use this formula:
FV due = 500 x [ ([1 + .06]^30 – 1) x (1 + .06) / .06]
After Jill does the math, she’d come up with a future value of $41,900.84.
Certified financial planner Lance Dobler, a senior regional director and vice president on TIAA’s private asset management team, says that calculating present and future values for an annuity can help give you peace of mind about your financial future.
“Knowing these numbers is simple in theory but very often overlooked in practice,” Dobler says. “Without up-to-date, dynamic forecasting, many investors fail to properly examine their investments and fail to include guaranteed lifetime income options that will help provide retirement security.”
This could mean delaying retirement or adjusting retirement income goals, Dobler says. “You also may need to either take on additional risk as you near retirement or, conversely, you may not be able to take on additional risk when trying to maximize legacy and philanthropic goals leading up to and into retirement.”
Get In Touch With A Pre-screened Financial Advisor In 3 Minutes
Looking For A Financial Advisor?
Get In Touch With A Pre-screened Financial Advisor In 3 MinutesVia Datalign Advisory
Was this article helpful?
Share your feedback Send feedback to the editorial team Thank You for your feedback! Something went wrong. Please try again later.
By Barbara Friedberg
By Taylor Tepper
By David Rodeck
By Barbara Friedberg
By Michael Adams
By David Rodeck
Information provided on Forbes Advisor is for educational purposes only. Your financial situation is unique and the products and services we review may not be right for your circumstances. We do not offer financial advice, advisory or brokerage services, nor do we recommend or advise individuals or to buy or sell particular stocks or securities. Performance information may have changed since the time of publication. Past performance is not indicative of future results.
Forbes Advisor adheres to strict editorial integrity standards. To the best of our knowledge, all content is accurate as of the date posted, though offers contained herein may no longer be available. The opinions expressed are the author’s alone and have not been provided, approved, or otherwise endorsed by our partners.
Personal Finance ExpertJohn Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.
© 2024 Forbes Media LLC. All Rights Reserved.
Are you sure you want to rest your choices?The Forbes Advisor editorial team is independent and objective. To help support our reporting work, and to continue our ability to provide this content for free to our readers, we receive compensation from the companies that advertise on the Forbes Advisor site. This compensation comes from two main sources. First, we provide paid placements to advertisers to present their offers. The compensation we receive for those placements affects how and where advertisers’ offers appear on the site. This site does not include all companies or products available within the market. Second, we also include links to advertisers’ offers in some of our articles; these “affiliate links” may generate income for our site when you click on them. The compensation we receive from advertisers does not influence the recommendations or advice our editorial team provides in our articles or otherwise impact any of the editorial content on Forbes Advisor. While we work hard to provide accurate and up to date information that we think you will find relevant, Forbes Advisor does not and cannot guarantee that any information provided is complete and makes no representations or warranties in connection thereto, nor to the accuracy or applicability thereof. Here is a list of our partners who offer products that we have affiliate links for.
