Annuity Calculator: How to Calculate Annuity Value?

Written by : Knowledge Centre Team

2021-08-13

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Rome was not built in a day! You can draw a parallel from this age-old pithy when you plan for your retirement. You must have a plan to save and grow that saving over the years so that you get a steady flow of money post-retirement and thus lead a comfortable retired life.

The concept of saving for retirement has another common ground with Rome. Annuity, as we know it today, dates back to the ancient Roman era when citizens kept lump-sum amounts in safe custody in return for a reliable stream of payments for a defined period.

This arrangement was termed, “annua”, which has now evolved to become “annuity”. However, this concept, quod est, is now referred to as “immediate annuity”.

The Safety of Guarantee

Modern consumers love the safety nets, called “guarantees” offered by sellers. Many companies even get customers to enter into extended support schemes called “Annual Maintenance Contracts (AMCs)” that give consumers peace of mind and comfort to the pocket.

Automobiles are covered by “motor insurance” whereas health is covered by “health insurance” to pay for expenses incurred to repair the vehicle or cover hospitalization. An annuity is also a type of guarantee to give you steady cash flow, post-retirement, for a defined period or sometimes until even the end of your life and that of your spouse as well.

The Legal Eagle

In legal parlance, an annuity is a contract between an insurance company and the person. The company is mandated to make periodic payments after a pre-defined date. In case the payments start immediately, the contract is called “Immediate Annuity'' and if the person invests money for a defined term after which the pay outs begin then the contract is called “Deferred Annuity”.

In the lesser-known type called the growing or increasing annuity, the cash flows grow at specific intervals of time. The saving period when you set aside a part of your income to build your retirement kitty is called the “Accumulation Phase” whereas the pay-out period is called the “Vesting Phase”.

Type of Annuities

In India, annuities are very popular financial instruments when planning for retirement. Considering the “assurance” that it provides and the risk (of outliving one’s income) that it mitigates, annuities are largely considered insurance products. Some other types of annuities widely offered by reputed insurers such as Canara HSBC Life Insurance are:

Life annuity: Annuities are paid in the opted frequency (monthly/quarterly/yearly) until your demise.
Life annuity with return of purchase price: You will get annuity pay outs in the opted frequency (monthly/quarterly/yearly) until your demise. After your demise, the corpus used to purchase the annuity is paid to your nominee.
Annuity Payable for a Guaranteed Period: The annuity is paid for the guaranteed period, even after your demise. Annuity stops either on your demise or on completion of the guaranteed period, whichever is later.
Joint life annuity: Annuities are paid until either you or your spouse is alive.
Joint life annuity with return of purchase price: These annuities are paid until you or your spouse is alive. After the demise of both, the nominee will get the amount initially invested.

How to Calculate the Present Value of Annuities?

If you are offered Rs. 1 Crore today vs Rs. 10 Lakhs paid each year for 10 years, you will opt for Rs.1 Crore today without batting an eyelid. You are aware that the purchasing power of the same amount would go down in the future due to the impact of inflation.

If you are 40 years old and expect your post-retirement expenses to be approximately Rs. 90,000 per month, you can use the present value formula/calculator to calculate the amount that you must start saving now.

The present value of a future pay out represents the amount of money today, which, if invested at a certain rate of interest, would grow to the amount that you will need then. This process of calculating the present value of future cash flows is also called “discounting”.

C = Cash flow per period (pay out amount)
n = Number of payments
i = Rate of Interest

The amount to be invested each month during the “accumulation phase” is inversely proportional to the rate of interest. Most annuity plans allow you to start investing at the age of 40. Therefore, if you want to invest in annuity plans, you must put your money into some robust high-growth insurance plans until 40 before moving your funds into annuity instruments.

As annuity plans are one of the safest investments of all time, the focus is on capital preservation rather than aggressive growth. So, if you are looking for growth, investing directly in annuity plans may not be the best investment decision.

Yet, you can invest your windfall gains into deferred annuity plans and reinvest the annuity income if you do not need it. This way you can keep your capital safe and enjoy better growth as well.

Click here to use - Compound Interest Calculator

How Much Annuity to Expect?

If you start investing Rs. 30,000 per month from the age of 40, and your investment gains an average interest of 7% per annum, you will accumulate approximately Rs. 1.6 Crores by the time you turn 60. At 6% per annum, this corpus can fetch you approximately Rs. 80,000 per month as a steady income stream post-retirement.

In a nutshell, you are investing Rs. 3.6 lakhs per year and getting a return of Rs. 9.6 lakhs per year.

Annuities are the best forms of savings if you are looking at safety, stability, and inflation-beating returns, in other words, post-retirement income stream.

For the ultimate peace of mind, you must invest your hard-earned money in insurance companies that have legacy and credibility in the market. After all, you are planning for several decades ahead-it is best to be in safe hands.

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