Annuities are investment products that make regular payments to investors over a specified period of time. Investors need to know an annuity's periodic payment amount, total payout amount and total interest payout over the life of the contract to gain a greater understanding of the annuity's expected performance. Calculating these three metrics can help you compare an annuity to other investment options.
Consult your annuity agreement to determine the annual interest rate, original principal amount and the number of payment periods per year. The principal amount is the price that you paid upfront for the annuity contract. The interest rate determines how much money the annuity pays out beyond the original principal.
Divide the annual interest rate by the number of payments per year to calculate the periodic interest rate. For example, if a 20-year annuity with an annual interest rate of 6 percent pays you twice a year, the periodic rate would be 3 percent (6 divided by 2). Use the annual interest rate as the periodic rate if the annuity pays out once a year.
Multiply the number of payments per year by 20, the number of years in the annuity, to calculate the total number of payments in the life of the annuity. In the biannual payment example above, the total number of payments would be 40 — twice a year times 20 years.
Use the following formula to determine the periodic payment of the annuity:
Payment = ( principal * periodic rate * ( 1 + periodic rate ) ^ total number of payments ) / ( ( 1 + periodic rate ) ^ total number of payments – 1 )
Multiply the periodic payment amount by the total number of payments to calculate the total amount to be received over the life of the annuity.
Subtract the original amount paid for the annuity from the total amount to be received to calculate the total gain on the annuity. Compare this number to other annuities, as well as to bonds' yield to maturity, to determine the value of the investment compared with similar options.
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