When building a retirement portfolio, you have many options to choose from. Stocks, bonds, mutual funds and exchange-traded funds (ETFs) can all be part of a basket of investments that will help you make sure you’re able to take care of yourself once you are done working. Annuities are a bit more complex than some other investments, but they provide guaranteed retirement income that can come in very handy in your retirement plan. It isn’t always easy to know exactly what an annuity will pay, though, so here let’s take a look at what a $100,000 fixed annuity will pay each month in your retirement.
Evaluating an annuity as a potential part of your retirement plan? Consider a financial advisor’s help. Finding one is easy with SmartAsset’s free financial advisor matching service.
What Is an Annuity?
An annuity is a financial contract between you and an insurance company that requires the insurance company to make periodic payments to you over a period of time. It is sometimes a source of retirement income when you want or need a guaranteed source of income without worrying about market fluctuations.
It’s possible to calculate the value of an annuity on your own using one of several methods. The variables that you need to know are the interest rate payable on the annuity and the length of time for which you will receive the periodic payments. You can also use a financial calculator to calculate the payment on an annuity in addition to the two methods shown. The insurance company from which you buy the annuity will have tables you can look at for a variety of combinations of interest rates and time periods.
Calculating Payments on an Annuity: Two Methods
Method 1
An annuity is an equal stream of payments over a given time. You can use the present value of an annuity formula, solving for payment, or an Excel spreadsheet. The formula for calculating the payment on an annuity is the following:
Payment = Principal x i (1+i)n / i (1 +i)n – 1
where i = monthly interest rate and n = number of payment periods. In this formula, the lower-case n is an exponent.
Imagine that you have paid $100,000 for an annuity that will make payments to you monthly for ten years. The interest rate you were promised in the annuity contract was 3%. You want to know how much you are paid each month:
Payment = $100,000 x 0.03/12 (1 + 0.03/12) 10 x 12 / (1 + 0.03/12)10 x 12 – 1 = $965.61
Method 2
Use the same example as above and change the interest rate to 5%, keeping the number of years at 10.
Using an Excel spreadsheet, you solve for payment. Here is the formula you use:
=PMT(i, n, PV)
In this equation, the following values are used:
i= interest rate/number of payment periods
n = number of years multiplied by number of payment periods
PV = present value of the annuity
In this case, enter the following in one cell:
=PMT (0.05%/12, 10 x 12, 100,000, 0) = $1,055.24
where i is the 5% interest rate divided by 12 monthly payments, n is the number of payment periods or 10 years times 12 monthly payment periods in each year and 100000 is the present value of the annuity.
The monthly payment on a $100,000 annuity if the interest rate is 5% and the time period is ten years is $1,055.24.
The present value of an annuity is based on the principles of time value of money. It is defined as the present value of the future cash flows generated by the annuity at a given interest rate and for a given time.
The monthly payments on an annuity increase if the interest rate increases or the term of the annuity decreases. The monthly payments would decrease if the interest rate decreased, or the term of the annuity increases.
The Bottom Line
It’s possible that you may want to include an annuity as part of your retirement planning. It depends on your risk preferences, your time horizon and your investment goals. It is generally a good idea to meet with a financial advisor and allow them to help you decide if an annuity fits within your financial plan. SmartAsset has a financial advisor matching tool that vets three financial advisors for you and allows you to pick the one most suited to your needs. If you’re ready, get started now.
Tips for Retirement
- A financial advisor can help you with annuities or any other retirement planning questions. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Would you like to determine how much you need to save for retirement? Use SmartAsset’s retirement calculator to help you calculate your retirement needs.
- Social Security likely won’t fund your entire retirement, but it can be a key part of making sure you have enough money to live on after your working days are done. Use SmartAsset’s free calculator to see how much you could get in Social Security payments once you are ready to retire.
Photo credit: ©iStock.com/Kirill Smyslov, ©iStock.com/megaflopp, ©iStock.com/da-kuk