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How To Calculate The Present Value And Future Value Of Annuities?

Present value is the amount of money needed to generate a specific return. Future value is the balance an account will accrue over time. Here are how these values of annuity are calculated.

  • Nov 17, 2022

Any form of recurring or ongoing payment is known as annuities. In case of annuity plans, a policyholder generally invests a lump sum amount in receiving a steady income after retirement. In a way, this helps retirees continue receiving a type of salary even after they stop working.

But while annuity plans are popular for retirement planning, the amount one chooses to invest in the plan needs careful consideration. After all, this lump sum investment will determine the payouts policyholder will receive after retirement. Calculating the present value and future value of the annuity is the right way to begin.

Understanding the concept: Present and Future Value of Annuities.

What is an Annuity?

  • An annuity is a type of financial investment that provides regular payments for a specified length of time. It is typically obtained through an insurance firm or a financial services organisation in modern times.
  • This form of investment is frequently employed by persons preparing for retirement or a planned spell of unemployment. An annuity can yield either fixed or variable returns, depending on the investor’s decisions.

  • When you buy an annuity, the insurance company takes a large sum of money and invests it, minus any expenses. In exchange, the investor will get an agreed-upon sum of money at regular intervals over a set length of time.

Present Value of an Annuity

  • The present value of an annuity is the current worth of all future income generated by that investment. In more practical terms, it is the sum of money that must be invested today in order to earn a certain amount of money afterwards.
  • For example, if you wish to ensure ₹1,000 annual payments for ten years, the present-value calculation would be used to decide how much to invest today. To obtain a ₹1,000 annuity payment for ten years at 8% interest, you would need to invest ₹6,710.08 now.

Future Value of an Annuity

  • The future value of an annuity is the entire amount of money that will be accrued by making regular investments with compound interest over a given period of time.
  • Rather than preparing for a certain amount of income in the future by calculating how much must be invested today, this method forecasts the growth of savings over time.
  • The future-value calculation would be used to predict the amount of an investment account, including interest growth, after ten years of making ₹1,000 monthly instalments. Assuming interest rates of 8% (which is also the growth rate), the potential value after 10 years is ₹19,990.05.

Why Should You Calculate Present Annuity Value?

The present annuity value is the current worth of the annuity payouts that a policyholder will receive in the future, depending on the insurer’s guaranteed rate of return. In other words, it helps one know the lump sum amount that should be invested in order to receive the desired annuity payouts after retirement.

As the calculation is used to determine the value of future annuity payments, it also helps determine whether an immediate annuity or a deferred annuity would be the right choice for an individual. Note that the calculation is based on the concept of the time value of money, wherein it is believed that the money received today has a higher value than the same amount received in the future.

How to Calculate the Present Value of Annuity?

The formula for present value of annuity calculator is as follows-

PV = P * [1 - ((1 + r) ^(-n)) / r]

P: Periodic Payment,
r: Periodic Interest Rate,
n: Number of Years

Why Should You Calculate Future Annuity Value?

The future annuity value is the total value of recurring payouts paid to the policyholder at a specific future date and a fixed discount rate. In simpler words, this calculation will help you know the true worth of the payments you are making towards an annuity plan at a future date.

This can help you make smarter investment decisions and plan your retirement as per your financial objectives and goals.

How to Calculate the Future Value of Annuity?

Given a set interest rate, the future value of the annuity formula is used to measure how much a series of regular payments will be worth at some time in the future. So, if you plan to invest a certain amount each month or year, it will tell you how much you will have amassed at a later period. If you make regular loan payments, the future value might help you calculate the overall cost of the loan.

The formula for calculating the future value of an annuity is as follows-

FV of annuity = P * [((1 + r) ^(n)) - 1 / r]
P is the Periodic Payment,
r is the Periodic Interest Rate,
n is the Number of Years

Annuity Calculator- A Simpler Way to Calculate Current Value and Future Value of Annuity

If these formulas are too confusing for you, a simpler alternative is to use an online annuity calculator. Most of the top insurers have this tool available on their websites to make it easier for buyers to choose the right annuity investment amount as per their retirement objectives.

If you are still unable to decide after using the annuity calculator, it’d be wise to get in touch with the insurer to get all the assistance you need. As the amount you invest in an annuity plan will determine the future payouts, be very careful with the amount you select to ensure that you can live your retirement years exactly how you’ve always imagined.

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Ref. No. KLI/23-24/E-BB/1052


- A Consumer Education Initiative series by Kotak Life

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