When markets are turbulent and recession rears its ugly head, investors may turn to annuities to help ease their worries that their retirement funds may be depleted. These investment vehicles can provide a steady, predictable source of income over the long term.
But how much does an annuity pay per month? It depends on the type of annuity you have, the payment term and the original investment.
how annuities work
An annuity is a contract between you and an insurance company. When you buy an annuity, the insurance company is required to make payments to you, either immediately or at a specific point in the future. In return, you pay premiums, either in lump sum or in instalments.
The annuities themselves are either immediate or deferred:
- Immediately. Together immediate annuityThe annuity is purchased with a lump sum contribution, and the annuity provides income payments to the annuitant within one year of its purchase.
- Adjourned. deferred annuities Annuities can be purchased with a lump sum contribution or instalments, and they provide income to the annuitant at a future date.
According to Melody Evans, wealth manager advisor with TIAA, annuities can be attractive because they provide periodic payments in retirement.
“Annuities provide certainty,” she says. “Fixed annuities may provide a known and stated credit rate and annuity payments provide a known and stated monthly payment.”
You pay no tax on the income and investment gains until you initiate the withdrawal. In this way, annuities provide tax-deferred growth.
How to Calculate Your Monthly Annuity Payment
Before purchasing an annuity, you’ll probably want to know how much you can expect in monthly payments.
According to Misty Garza, certified financial planner and vice president of Bogart Wealth, annuity payments vary based on several factors.
“Annuity payments are a function of the individual’s age, the current mortality table, current interest rates and how much is being put into the annuity,” she says.
Although there are three main types of annuitiesVariable, Indexed and Fixed—For demonstration purposes, we’ve focused on calculating the monthly payouts offered by fixed annuities.
Together a fixed annuity, the insurance company guarantees that the payment will be the minimum rate of principal and interest. As long as the insurance company you choose is financially stable, the money you have in a fixed annuity will grow, and it won’t drop in value.
To calculate your payout, consider the following variables:
- principal balance. The principal of your annuity is what you paid to buy it. You may have bought it in lump sum or with installment payments; The principal is the total contribution you have made, less any fees or charges. The higher your principal, the higher your monthly payment.
- Rate of interest. Fixed annuities have a minimum interest rate, so the interest rate will never be below that number. The minimum rate should be listed on your annuity statement or contract.
- payment schedule. Some annuities pay you in installments for a specific period, such as 10 years, while others may give you installment payments for the rest of your life. If you also get paid every month, then the payout schedule will be affected.
- inflation. Price increases throughout the economy gradually reduce the purchasing power of your annuity payments. Some annuities offer optional inflation protection riders, which can reduce the amount of your initial monthly payments but preserve the value of ongoing payments over the long term.
Annuity Payment Formula
The formula to calculate your annuity payment is:
p = (d[1-(1 + r/k)-nk])/(r/k)
- P: Annuity balance at the beginning of the payment term
- D: regular withdrawal amount
- R: annual interest rate in decimal form
- K: the number of compounding periods; Since we’re calculating the monthly payment, we used 12.
- N: Number of years you plan to take the withdrawal
Assuming a lump sum contribution of $100,000, an interest rate of 4% and a payment term of 10 years, here’s how to calculate your monthly payment:
$100,000 = (D[1-(1 + 0.04/12)-10*12])/(0.04/12)
Using that formula, you can find your monthly payment with different terms:
If math isn’t your strong point, or if you’re just looking for a faster method, you can use any number of online annuity payment calculators.
Annuities and Retirement Planning
In general, experts recommend that annuities complement your retirement savingsBut they shouldn’t make up your entire plan.
“Annuities have their place for some individuals, but they’re not for everyone,” says Garza. “I think it’s important to understand someone’s risk tolerance and comfort level with the market to determine whether they would be better off with an annuity for an income stream.”
When considering whether an annuity is right for you—and how large to buy—keep in mind that annuities lock up your cash.
“biggest [drawback] If you have a big expense, you no longer have a big pot to pull money into,” says Garza. “Because of this, it’s important to make sure you don’t put all your money in the annuity.”
Unlike bank accounts, annuities are not insured by the government through the Federal Deposit Insurance Corporation (FDIC).FDIC, As you consider your options and weigh the pros and cons of annuities, consultation with a financial advisor can help you create a plan that works for you.
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