How to Calculate Cash Values of Annuities

Annuities, such as bond coupons, offer fixed payments over time.

Annuities, such as bond coupons, offer fixed payments over time.

An annuity's cash value is a single sum that you receive in lieu of annuitized payments. This value is less than the total of the annuity's separate payments, but you can invest the cash value and receive returns, producing a sum larger than the annuitized total. You can also invest the annuity's payments to receive returns on them, and this too produces an amount larger than the combined annuitized payments. At a constant interest rate, the lump sum and annuitized payments should have the same future value.

Add 1 to the interest rate. For example, if you plan to invest the annuity's payments at an interest rate of 6 percent, add 1 to 0.06 to get 1.06.

Raise this sum to the power of the number of years in the annuity. For example, if the annuity pays you for five years, raise 1.06 to the power of 5 to get 1.338.

Subtract 1 from your answer to get 0.338.

Divide your answer by the interest rate. Continuing the example, divide 0.338 by 0.06 to get 5.63.

Multiply this value by the size of the annuity's first payment. For example, if the annuity pays $1,000 each year, multiply $1,000 by 5.63 to get $5,630, the annuity's future value.

Divide this future value by the annual multiplier on your lump sum, which you calculated in Step 2. Continuing the example, divide $5,630 by 1.338 to get $4,208. This is the annuity's cash value.

Photo Credits

  • Jupiterimages/ Images