An annuity is a type of insurance contract designed to grow your savings for the future. At this point, it'll turn your balance into retirement income. As part of planning your upcoming budget, it's useful to know just how much you'll end up with from your investment. Having a basic understanding of the present value vs. future value in annuities can help you with this estimate.
Understanding Present Value vs. Future Value for Annuities
The present value of an annuity is what it's worth today. If you already own an annuity, it's how much you would get back if you cashed out now (though taxes and early cancellation charges from the annuity company could reduce this total). Your annuity policy statements and online account should show you the current present value.
If you don't own an annuity, the present value is also what you would need to spend on a contract today to hit your future income goals. The future value of an annuity is what your contract will be worth at some point later, based on your investment earnings and contributions.
Calculating Present vs. Future Value
If you bought your annuity using a single lump sum, meaning you won't add any more money to the account, calculating the future value is relatively straightforward. You need three pieces of information: the current present value, the annual investment return, and the number of years you want to predict in the future.
The future value of an annuity = the present value x (1+ r)n, where r is the interest rate and n is the number of years in the future you want to predict.
For example, let's say you have an annuity with a present value of $100,000, it's earning 5% a year, and you want to calculate the future value in five years. The calculation would work out as following:
FV = PV x (1 +r)n
= $100,000 x (1 + 5%)5
= $100,000 x (1.05)5
= $100,000 x (1.27628)
Alternatively, you can flip the formula around to see how much you would need to save today to reach a future savings goal. The formula then becomes PV = FV/(1+r)n. Let's say you want $150,000 in five years and have an annuity earning 5% annually.
PV = $150,000/(1+5%)5 = $117,529. This is how much you would need to deposit to reach your future goal.
Handling Annuities With Ongoing Payments
If you're still adding money to your annuity, this calculation gets more complicated. It's best to run the numbers using a calculator. If you are saving money each year in an annuity and want to know what it will be worth in the future after investing, you can use a future value calculator to see its projected value.
If you want to generate a certain amount of retirement income, like $20,000 a year, and want to know how much you would need in an annuity to reach that amount, you can use another calculator to find the present value of an annuity needed to generate those ongoing future payments.
Finding Your Annuity Growth Rate
As part of figuring out the future value of your annuity, you need to know your investment return. This depends on the type of annuity you have.
In a fixed annuity, you earn a set return that's guaranteed by your annuity company. This makes it easy to calculate the future value because you know exactly how much your savings will grow each year.
If you have a fixed index or variable annuity, your annual return is based on the market. What you earn each year can go up and down. Since your return isn't guaranteed, you'll need to estimate based on how you think your investments will do.
You could try running the numbers to see what your retirement savings would look like for different returns. For example, you see what the future value would be if your annual return is 4% for a disappointing performance, 7% for an okay performance, and 10% if things go really well. That way, you can plan your savings and retirement budget for all three scenarios.
If you need help predicting the values for an annuity, your insurance company could run the numbers for you. They have the software to easily handle these annuity calculations and can tell you where your contract will likely end up.
You could also discuss it with your insurance agent to see whether your current approach fits your goals or if you should make any adjustments to your savings plan.
Retirement planning means trying to predict where your finances will be in the future. The present value vs. future value calculations can give you the information needed to figure this out.