An annuity is a kind of insurance or investment that provides a source of income with periodic payments. It can be an effective supplement to your pension, but it can also be unclear. Learning to understand how the annuities work and the income deriving from them that you can rely on, can be a useful tool for planning your future, consequently allowing you to organize other types of investment as well. To get started calculating annuity payments, check out the following article so that you can also accurately estimate your future income.
Steps
Step 1. Determine the type of annuity
- Annuities can be fixed or variable. A fixed annuity will have guaranteed payments, while a variable annuity is highly dependent on the performance of the underlying investments.
- The annuity can be postponed, i.e. the installments can be postponed from a certain date. Or it can be immediate; in this case, payments begin as soon as the first payment is made.
Step 2. Choose the annuity payment method
- The most common one involves the payment of the entire sum in a certain period of time, with any residual that is paid to the beneficiary upon the death of the insured.
- There are other methods that provide for both the payment of the annuity to the insured and to the spouse of the insured for life, as indeed there are payment methods that are the result of the combination of two or more ways.
Step 3. Identify the other characteristics of the annuity, including payment and balance rules and the interest rate
Step 4. Calculate the amount of the installments based on the particular annuity situation
- For example, let's assume an annuity of 500,000.00 euros with an interest rate of 4 percent that pays a fixed annual amount for the next 25 years.
- The formula for the calculation is: Annuity Value = Initial Payment x Present Annuity Value (VAR). In the section dedicated to Sources and Citations there are links to deepen this topic.
- The VAR for the above scenario is 15, 62208. 500.000, 00 = Rate x 15, 62208. This equation should be simplified by isolating the unknown variable and then dividing the two factors by 15, 62208; Installments = 32.005, 98 euros.
- You can also use Excel to calculate the amount of the installments with the "INSTALLMENT" function. The syntax is as follows: "= RATA (RateInterest; NumeroPeriodi; ValoreAttuale; ValoreFuturo; TipoPagamento)". Enter "0" for the variable relating to the type of payment (advance or deferred). In the above example, you would have had to type "= PAYMENT (0, 04; 25; -500000; 0)" in a cell and press "Enter". Spaces must not be used in the function. Excel will give the result of 32.005.98 euros.
Step 5. Corrections to be made if the annuity is not paid for some years
- To calculate the future value of the initial payment, you can use specific tables relating to the Future Value, the interest rate that accrues on the annuity starting from the initial payment at the time the first installment will be paid and the number of years that separate you. of the start of payments.
- For example, let's assume that the initial $ 500,000 will earn you 2 percent annual interest until the annuity begins after 20 years. You have to multiply 500.000, 00 by 1.48595 (the factor of the future value detectable by the tables) to get 742.975, 00.
- In Excel, the future value can be calculated with the "ISFUT" function. The syntax is as follows: "= VAL. FUT (Interest Rate; NumeroPeriodi; Payments; Present Value; Type)". Enter "0" for the variable relating to additional payments and for the type of payment (advance or deferred). So in our example we will have "= ISFUT (0, 02; 20; 0; -500000)".
- At this point this future value is substituted for the value of the initial payment and the installments are recalculated using the formula "Value of the Annuity = Initial Payment x VAR". Given the variables calculated before, the annual installment will be 47.559, 29 euros.
