How to Calculate an Annuity Payout
Nov 10, 2023
Blueprint Income Team
An annuity can provide you with a fixed income over a set period of time. The easiest way to complete any annuity calculation is with an online annuity calculator. This allows you to plug in the numbers and get a quick response. However, fully understanding your annuity payout takes more than a few clicks of the mouse.
This is where it can help to take a look at the underlying annuity calculation formulas that determine your periodic payment amounts as well as the value of your annuity now and in the future. Running these calculations gives you detailed information to better understand your annuity payments over time and the full annuity payout that you can enjoy.
Table of Contents
Annuity calculation for payouts
When you contribute to an annuity, you'll receive detailed documentation on the payout schedule for this investment. Annuity payouts can occur in many ways, as we'll explore below. If you've lost track of your payment schedule and want to determine what your annuity payout will be, you can calculate this with a few key pieces of information. You must know the:
- Principal amount (P): This is the total sum that you contributed to the annuity. Depending on the annuity structure, you might pay this upfront or contribute to it over a series of payments.
- Number of payments (N): Determine how often the annuity pays out each year and multiply this by the number of years in your annuity term. This will give you the total number of payments. If you have a lifetime annuity that will pay out regularly as long as you live, some of these numbers are based on estimates that you can obtain from your annuity provider.
- Annual interest rate: Your annuity may have a fixed or variable interest rate. If the rate changes, you will need to update your calculations. For this calculation, use the current interest rate as it applies to your annuity.
- Periodic interest rate (R): Divide the annual interest rate by the number of annuity payments you receive in a year to determine the periodic interest rate for each individual payment.
With these numbers in hand, you can determine your period annuity payout using the following formula:
Annuity payment = (P * R * (1 + R)^N)/((1 + R)^N) – 1)
To determine the total annuity payout over the life of the annuity, multiply the annuity payment as determined above by the number of payments (N) that you will receive.
Annuity calculation for future and present value
While the above calculations will help you determine your period payment amount and the total sum of those payments, they leave out one important piece of information. The value of your annuity as a whole today is not the same as the value of your annuity in the future. This is due to a factor called the time value of money.
The time value of money principle states that money in the future has a lower value than money in the present. The time value of money is based upon the assumption of inflation and the idea that you could invest present money to increase its value. Thus, your annuity will have a different value when assessed at its present value versus its future value.
To perform these calculations, you must know the value of each payment (PMT), the interest rate per period (r), and the number of periods that the annuity will pay out (n). You can plug this information in as follows:
Future value = P × ((1 + r)n - 1)/r
Present value = P × (1 − (1 + r) - n)/r
Immediate versus deferred annuities
You will begin to receive payouts from your annuity on a set schedule that's determined when you purchase the annuity. There are two basic options: immediate annuities and deferred income annuities.
An immediate annuity will begin issuing payments to you right away. There's no waiting period to begin enjoying the perks of this annuity. The sum that you contribute is tax-free while it remains in the annuity and you will receive only a portion of that sum in each payout.
A deferred annuity starts gives you the option to start taking payments in the future. Most people use annuities as a retirement investment, and begin taking payments from the annuity in their retirement years. Purchasing an annuity prior to retirement allows for funds to accumulate prior to taking income.
Annuity payout options
Annuities may pay out in a number of ways. Below are some of the most common annuity payout options:
Straight life annuity
Also referred to as a life-only annuity, this investment protects you from the possibility of running out of payments during your lifetime. You will receive a guaranteed income payment at predetermined periods for the rest of your life. The risk is that you may not receive the full sum of your contribution before you die. However, if you outlive that contribution, you will continue to get regular payments for as long as you live.
Life with period certain
A life with period certain annuity works much the same as a straight life annuity, in that it will give you regular payments for life. However, the life with period certain annuity adds one more feature. The annuity will continue to pay out to your designated beneficiary if you should die before the guarantee period expires. This is a nice perk, but it usually results in smaller periodic annuity payments than would a straight life annuity.
Joint and survivor
A joint and survivor annuity, also known as a couples annuity, provides lifetime payments to both the annuitant and their spouse. If the annuitant dies before their spouse, the spouse will continue to get regular payments for the duration of their life. Depending on the annuity, the spouse may receive full payments or a reduced amount (like 50% of the original payments).
Fixed period annuity
A fixed period, or period certain, annuity does not offer payments for life. Rather, it delivers payments for a set number of periods. The payments from a fixed period annuity are usually higher, but you run the risk of receiving payments for only a portion of your retirement. If you choose this option, it's best to have other investments in place to support you through additional years of retirement once the annuity has run out.
A fixed amount annuity, also known as a systematic withdrawal schedule, allows you to determine the sum of your payments. You will continue to receive payments at this amount until the annuity's value runs out. You can use an annuity calculator to experiment with different payment amounts and see how long your annuity will last. As with a fixed period annuity, this option doesn't guarantee payments for life.
Lump sum payment
A lump sum annuity payment allows you to cash out the full sum of the annuity at a particular point in time. The drawback is that you'll have to pay income taxes all at once on any accumulated funds. It's best to speak with a tax professional about the implications of taking a lump sum payment before you opt for this route.
Alternative annuity payout options
If you need to access more funds than your annuity is currently providing, there are a few options available to you. Check your annuity contract for your liquidity options.
In most cases, you will pay a surrender charge if you withdraw annuity funds in the early years of an annuity, although some annuities allow a certain portion (e.g., 10%) to be withdrawn without a charge. If you take any withdrawal before you reach the age of 59 1/2, you will likely pay a 10% federal tax penalty. If you're concerned that you may need to cash out some funds from your annuity early, it's important to examine the rules regarding early withdrawals and to seek out an annuity that provides favorable conditions for this type of action.
You may also have the option to sell some or all of your annuity payments for upfront cash. In this case, the buyer will typically use the present value of your annuity to determine the purchase price, though this is lower than the future value of the investment. If you don't need to cash out the full sum of your annuity investment, you can sell only a few of your payments for upfront cash. In this case, your annuity payments will resume again at a future date.
Understanding how to calculate your annuity payout options will help you manage your annuity in the best way possible. If you're interested in learning more about annuities and finding the right product for your needs, our team at Blueprint Income can help. Get started with our intuitive quick start guide today.
Blueprint Income Team
We are a team of finance, insurance, and actuarial professionals working to make it easier for everyone to achieve a steady and comfortable retirement. We write about annuities (the good and the bad) and provide strategies to help Americans prepare for retirement.