What Is It, Formula, and Calculation

Contents

What Is the Future Worth of an Annuity?

The longer term worth of an annuity is the worth of a bunch of recurring funds at a sure date sooner or later, assuming a selected fee of return, or low cost fee. The upper the low cost fee, the higher the annuity’s future worth. So long as the entire variables surrounding the annuity are recognized equivalent to fee quantity, projected fee, and variety of intervals, it’s attainable to calculate the long run worth of the annuity.

Key Takeaways

• The longer term worth of an annuity is a approach of calculating how a lot cash a sequence of funds can be value at a sure level sooner or later.
• Against this, the current worth of an annuity measures how a lot cash can be required to supply a sequence of future funds.
• In an abnormal annuity, funds are made on the finish of every agreed-upon interval. In an annuity due, funds are made initially of every interval.
• To calculate the long run worth of an annuity, you need to know the annuity fee quantity, variety of intervals, and projected fee of return.
• As a result of annuity due funds typically entail having a further compounding interval, the long run worth of an annuity due will often be increased than the long run worth of an annuity.

Understanding the Future Worth of an Annuity

Due to the time worth of cash, cash acquired or paid out immediately is value greater than the identical amount of cash can be sooner or later. That is as a result of the cash may be invested and allowed to develop over time. By the identical logic, a lump sum of $5,000 immediately is value greater than a sequence of 5$1,000 annuity funds unfold out over 5 years.

System and Calculation of the Future Worth of an Annuity

The components for the long run worth of an abnormal annuity is as follows. (An abnormal annuity pays curiosity on the finish of a selected interval, quite than initially, as is the case with an annuity due.)



P

=

PMT

×

(

(

1

+

r

)

n

1

)

r

the place:

P

=

Future worth of an annuity stream

PMT

=

Greenback quantity of every annuity fee

r

=

Curiosity fee (additionally recognized as low cost fee)

n

=

Quantity of intervals in which funds will be made

beginaligned &textP = textPMT occasions frac huge ( (1 + r) ^ n – 1 huge ) r &textbfwhere: &textP = textFuture worth of an annuity stream &textPMT = textDollar quantity of every annuity fee &r = textInterest fee (also referred to as low cost fee) &n = textNumber of intervals through which funds can be made endaligned

P=PMT×r((1+r)n1)the place:P=Future worth of an annuity streamPMT=Greenback quantity of every annuity feer=Curiosity fee (additionally recognized as low cost fee)n=Quantity of intervals in which funds will be made

Future Worth of an Annuity Due

With an annuity due, the place funds are made initially of every interval, the components is barely completely different. To search out the long run worth of an annuity due, merely multiply the components above by an element of (1 + r). So:



P

=

PMT

×

(

(

1

+

r

)

n

1

)

r

×

(

1

+

r

)

beginaligned &textP = textPMT occasions frac huge ( (1 + r) ^ n – 1 huge ) r occasions ( 1 + r ) endaligned

P=PMT×r((1+r)n1)×(1+r)

Future Worth of an Annuity Instance

Assume somebody decides to take a position $125,000 per yr for the following 5 years in an annuity they anticipate to compound at 8% per yr. On this instance, the sequence of funds is a daily annuity through which the funds are made on the finish of every interval. The anticipated future worth of this fee stream utilizing the above components is as follows:  Future worth =$

125

,

000

×

(

(

1

+

0.08

)

5

1

)

0.08

=

733 , 325 beginaligned textFuture worth &=125,000 occasions frac huge ( ( 1 + 0.08 ) ^ 5 – 1 huge ) 0.08 &= 733,325 endaligned Future worth=125,000×0.08((1+0.08)51)=$733,325 Future Worth of an Annuity Due Assume the identical instance as above was an annuity due. This implies every of the$125,000 funds was made initially of every interval. Its future worth can be calculated as follows:



Future worth

=

$125 , 000 × ( ( 1 + 0.08 ) 5 1 ) 0.08 × ( 1 + 0.08 ) =$

791

,

991

beginaligned textFuture worth &= $125,000 occasions frac huge ( ( 1 + 0.08 ) ^ 5 – 1 huge ) 0.08 occasions ( 1 + 0.08 ) &=$791,991 endaligned

Future worth=$125,000×0.08((1+0.08)51)×(1+0.08)=$791,991

The Backside Line

An annuity is a sequence of funds revamped a time period, typically for a similar quantity every interval. Buyers can decide the long run worth of their annuity by contemplating the annuity quantity, projected fee of return, and variety of intervals. There are additionally implications whether or not the annuity funds are made initially of the interval or on the finish.