The Annuity Formula for the Present and Future Value of Annuities

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1. Guide to Annuities: What They Are, Types, and How They Work
2. What Is an Annuity?
3. The Main Types of Annuities
4. An Overview of Annuities
5. Life Insurance vs. Annuity
6. Difference Between IRA and an Annuity
7. Best Age to Get an Annuity

Types of Annuities: Part 1

1. Deferred Annuity
2. Fixed Annuity
3. Immediate Payment Annuity
4. Indexed Annuity
5. Individual Retirement Annuity

Types of Annuities: Part 2

1. Joint and Survivor Annuity
2. Ordinary Anniuity
3. Qualified Longevity Annuity Contract

Calculating Present and Future Value

1. Present Value Annuity
2. Future Value Annuity
3. Calculating Present and Future Value Annuities

1. How Are Nonqualified Variable Annuities Taxed?
2. How a Fixed Annuity Works After Retirement
3. What Happens to an Annuity After You Die

Payouts, Distributions, and Withdrawals

1. Selecting the Payout on Your Annuity
2. Are Variable Annuities Subject to Required Minimum Distributions?
3. How to Rollover a Variable Annuity Into an IRA
4. Distribution Options for an Inherited Annuity
5. Penalties for Withdrawing Money From Annuities
6. Borrowing From an Annuity to Put a Down Payment

Benefits and Risks

1. SPONSORED: How to Navigate Market Volatility While Saving for Retirement Sponsored
2. The Whole Story on Variable Annuities
3. Pros and Cons of Retirement Annuities
4. Biggest Disadvantages of Annuities
5. Risks of Annuities in a Recession

Most of us have had the experience of making a series of fixed payments over a period of time, such as rent or car payments, or of receiving a series of payments for a period of time, such as interest from a bond or certificate of deposit (CD).

These recurring or ongoing payments are technically referred to as annuities (not to be confused with the financial product called an annuity, though the two are related).

There are several ways to measure the cost of making such payments or what they're ultimately worth. Read on to learn how to calculate the present value (PV) or future value (FV) of an annuity.

Key Takeaways

• Recurring payments, such as the rent on an apartment or interest on a bond or CD are sometimes referred to as annuities.
• Ordinary annuities and annuities due differ in the timing of those recurring payments.
  
• The future value of an annuity is the total value of payments at a future point in time.
• The present value is the amount of money required now to produce those future payments.
• Knowing the figures for FV and PV can help you make better informed decisions about your financial planning and investing needs.

Two Types of Annuities

Annuities, in the ongoing payments sense of the word, break down into two basic types: ordinary annuities and annuities due.

• Ordinary Annuities: An ordinary annuity makes (or requires) payments at the end of a particular period. For example, bonds generally pay interest at the end of every six months.
• Annuities Due: An annuity due, by contrast, involves payments that are made at the beginning of each period. Rent, which landlords typically require at the beginning of each month, is a common example.
  

You can calculate the present or future value for an ordinary annuity or an annuity due using the formulas shown below.

With ordinary annuities, payments are made at the end of a specific period. With annuities due, they're made at the beginning of the period. The difference affects value because annuities due have a longer amount of time to earn interest.

Calculating the Future Value of an Ordinary Annuity

FV is a measure of how much a series of regular payments will be worth at some point in the future, given a specified interest rate.

So, for example, if you plan to invest a certain amount each month or year, FV will tell you how much you will accumulate as of a future date. If you are making regular payments on a loan, the FV is useful in determining the total cost of the loan.

Consider, for example, a series of five $1,000 payments made at regular intervals.

Because of the time value of money—the concept that any given sum is worth more now than it will be in the future because it can be invested in the meantime—the first $1,000 payment is worth more than the second, and so on.

So, let's assume that you invest $1,000 every year for the next five years, at 5% interest. Below is how much you would have at the end of the five-year period.

Now, rather than calculating each payment individually and then adding them all up, as we did above, you can use the following formula to calculate how much money you'd have in the end:

FV Ordinary Annuity = C × [ ( 1 + i ) n − 1 i ] where: C = cash flow per period i = interest rate n = number of payments \begin &\text_> = \text \times \left [\frac < (1 + i) ^ n - 1 > < i >\right] \\ &\textbf \\ &\text = \text \\ &i = \text \\ &n = \text \\ \end ​ FV Ordinary Annuity ​ = C × [ i ( 1 + i ) n − 1 ​ ] where: C = cash flow per period i = interest rate n = number of payments ​

Using the example above, here's how it would work:

FV Ordinary Annuity = $ 1 , 000 × [ ( 1 + 0.05 ) 5 − 1 0.05 ] = $ 1 , 000 × 5.53 = $ 5 , 525.63 \begin \text_> &= \$1,000 \times \left [\frac < (1 + 0.05) ^ 5 -1 > < 0.05 >\right ] \\ &= \$1,000 \times 5.53 \\ &= \$5,525.63 \\ \end FV Ordinary Annuity ​ ​ = $1 , 000 × [ 0.05 ( 1 + 0.05 ) 5 − 1 ​ ] = $1 , 000 × 5.53 = $5 , 525.63 ​

Note that the one cent difference in these results, $5,525.64 vs. $5,525.63, is due to rounding in the first calculation.

Calculating the Present Value of an Ordinary Annuity

In contrast to the FV calculation, PV calculation tells you how much money would be required now to produce a series of payments in the future, again assuming a set interest rate.

Using the same example of five $1,000 payments made over a period of five years, here is how a PV calculation would look. It shows that $4,329.48, invested at 5% interest, would be sufficient to produce those five $1,000 payments.

This is the applicable formula:

 PV Ordinary Annuity = C × [ 1 − ( 1 + i ) − n i ] \begin &\text_> = \text \times \left [ \frac < 1 - (1 + i) ^ < -n >> < i >\right ] \\ \end ​ PV Ordinary Annuity ​ = C × [ i 1 − ( 1 + i ) − n ​ ] ​ 

If we plug the same numbers as above into the equation, here is the result:

 PV Ordinary Annuity = $ 1 , 0 0 0 × [ 1 − ( 1 + 0 . 0 5 ) − 5 0 . 0 5 ] = $ 1 , 0 0 0 × 4 . 3 3 = $ 4 , 3 2 9 . 4 8 \begin \text_> &= \$1,000 \times \left [ \frac > < 0.05 >\right ] \\ &=\$1,000 \times 4.33 \\ &=\$4,329.48 \\ \end PV Ordinary Annuity ​ ​ = $ 1 , 0 0 0 × [ 0 . 0 5 1 − ( 1 + 0 . 0 5 ) − 5 ​ ] = $ 1 , 0 0 0 × 4 . 3 3 = $ 4 , 3 2 9 . 4 8 ​ 

Calculating the Future Value of an Annuity Due

​As mentioned, an annuity due differs from an ordinary annuity in that the annuity due's payments are made at the beginning, rather than the end, of each period.

To account for payments occurring at the beginning of each period, the ordinary annuity FV formula above requires a slight modification. It then results in the higher values shown below.

The reason the values are higher is that payments made at the beginning of the period have more time to earn interest. For example, if the $1,000 was invested on January 1 rather than January 31, it would have an additional month to grow.

The formula for the FV of an annuity due is:

FV Annuity Due = C × [ ( 1 + i ) n − 1 i ] × ( 1 + i ) \begin \text_> &= \text \times \left [ \frac< (1 + i) ^ n - 1> < i >\right ] \times (1 + i) \\ \end FV Annuity Due ​ ​ = C × [ i ( 1 + i ) n − 1 ​ ] × ( 1 + i ) ​

Here, we use the same numbers as in our previous examples:

FV Annuity Due = $ 1 , 000 × [ ( 1 + 0.05 ) 5 − 1 0.05 ] × ( 1 + 0.05 ) = $ 1 , 000 × 5.53 × 1.05 = $ 5 , 801.91 \begin \text_> &= \$1,000 \times \left [ \frac< (1 + 0.05)^5 - 1> < 0.05 >\right ] \times (1 + 0.05) \\ &= \$1,000 \times 5.53 \times 1.05 \\ &= \$5,801.91 \\ \end FV Annuity Due ​ ​ = $1 , 000 × [ 0.05 ( 1 + 0.05 ) 5 − 1 ​ ] × ( 1 + 0.05 ) = $1 , 000 × 5.53 × 1.05 = $5 , 801.91 ​

Again, please note that the one cent difference in these results, $5,801.92 vs. $5,801.91, is due to rounding in the first calculation.

Calculating the Present Value of an Annuity Due

Similarly, the formula for calculating the PV of an annuity due takes into account the fact that payments are made at the beginning rather than the end of each period.

For example, you could use this formula to calculate the PV of your future rent payments as specified in your lease. Let's say you pay $1,000 a month in rent. Below, we can see what the next five months would cost you, in terms of present value, assuming you kept your money in an account earning 5% interest.

This is the formula for calculating the PV of an annuity due:

PV Annuity Due = C × [ 1 − ( 1 + i ) − n i ] × ( 1 + i ) \begin \text_> = \text \times \left [ \frac > < i >\right ] \times (1 + i) \\ \end PV Annuity Due ​ = C × [ i 1 − ( 1 + i ) − n ​ ] × ( 1 + i ) ​

So, in this example:

PV Annuity Due = $ 1 , 000 × [ ( 1 − ( 1 + 0.05 ) − 5 0.05 ] × ( 1 + 0.05 ) = $ 1 , 000 × 4.33 × 1.05 = $ 4 , 545.95 \begin \text_> &= \$1,000 \times \left [ \tfrac < (1 - (1 + 0.05) ^< -5 >> < 0.05 >\right] \times (1 + 0.05) \\ &= \$1,000 \times 4.33 \times1.05 \\ &= \$4,545.95 \\ \end PV Annuity Due ​ ​ = $1 , 000 × [ 0.05 ( 1 − ( 1 + 0.05 ) − 5 ​ ] × ( 1 + 0.05 ) = $1 , 000 × 4.33 × 1.05 = $4 , 545.95 ​

What's the Difference Between an Ordinary Annuity and an Annuity Due?

An ordinary annuity is a series of recurring payments that are made at the end of a period, such as payments for quarterly stock dividends. An annuity due, by contrast, is a series of recurring payments that are made at the beginning of a period. Monthly rent or mortgage payments are examples of annuities due.

What's the Difference Between the Present Value and Future Value?

Present value tells you how much money you would need now to produce a series of payments in the future, assuming a set interest rate.

Future value, on the other hand, is a measure of how much a series of regular payments will be worth at some point in the future, given a set interest rate. If you're making regular payments on a mortgage, for example, calculating the future value can help you determine the total cost of the loan.

What's the Present Value of an Annuity?

The present value of an annuity refers to how much money would be needed today to fund a series of future annuity payments. Or, put another way, it's the sum that must be invested now to guarantee a desired payment in the future.

The Bottom Line

The formulas described above make it possible—and relatively easy, if you don't mind the math—to determine the present or future value of either an ordinary annuity or an annuity due. Such calculations and their results can add confidence to your financial planning and investment decision-making.

Excel can help you calculate the PV of fixed annuities. Financial calculators also have the ability to calculate these for you, given the correct inputs.