How to Calculate Annuities with Inflation

Inflation limits your gains from long-term investments.

Inflation limits your gains from long-term investments.

When an annuity issues you a series of payments, you can use the payments to make further contributions to the annuity. This compounded interest that acts on the cash flows suggests very high returns over time. However, inflation leaves money that you receive in the future worth less than money you receive now. To more accurately judge an annuity's worth, you should calculate its present value, which describes its total worth in terms of today's dollars, taking inflation into account.

Add 1 to the interest rate on the annuity's cash flows. An annuity's documentation states its anticipated average return rate, or you can assume a rate equal to the Treasury's rate on risk-free securities. For example, if the annuity will grow by 4 percent each year, add 1 to 0.04 to get 1.04.

Multiply the number of years in the annuity by -1. For example, if the annuity issues payments for five years, multiply 5 by -1 get -5.

Raise your first answer to the power of your second answer. Continuing the example, raise 1.04 to the power of -5 to get 0.822.

Subtract this answer from 1, to get 0.178.

Divide this value by the interest rate. Continuing the example, 0.178 divided by 0.04 is 4.45.

Multiply the answer by the value of a single payment. For example, if the annuity issues $1,000 with each payment, multiply $1,000 by 4.45 to get $4,450, which is the annuity's value after five years when you factor in inflation.


About the Author

Ryan Menezes is a professional writer and blogger. He has a Bachelor of Science in journalism from Boston University and has written for the American Civil Liberties Union, the marketing firm InSegment and the project management service Assembla. He is also a member of Mensa and the American Parliamentary Debate Association.

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