Annuity – Annuities and how they add up

If you have succeeded in adding to the basic understanding of an annuity or annuities, then you will have made a contribution to yourself.  An annuity is somewhat basic; however, understanding how to calculate the value of each contribution can sometimes seem baffling.  Explained in this article is the basic understanding of an annuity and how they add up for your contribution.
 

To begin with, an annuity or annuities is basically a structure of accumulating a lump sum of money through a series of regular and evenly balanced payments.  As with the reverse being the liquidation of a sum through a series of regular and evenly balanced payments.

The process to annuitize a sum of money means to convert the sum to a series of monthly incomes to that of a design of a monthly retirement income flow.   To understand the math involved in the calculation, you would have to understand the basics of simple and compound interest.  The process involves the collaboration of value and time and the interest rate. 

An example of an ordinary annuity certain is as follows.  What is the value of a monthly contribution of $100 over 5 years at an interest rate of 5% that is compounding monthly?

You could go through the process of calculating the value of each contribution using a simple interest formula.  This can be calculated using a formula because the contribution amount and the intervals are consistent however this formula could be a lot of work.

Listed below is the annuity formula to use:

                

FV = PMT [(1 + i )n -1]  divided over i    FV = Future Value  PMT = amount of periodic payment  n = number of compounding periods  i equals interest rate

Insert the numbers into the equation and you get:

Payment = 100  N = 5 years X 12 months = 60   I = .05/12 = .004167 = 6,800.68

The lump sum converted to an annuity payout.  Consider you have a lump sum of money that is to be paid out as a series of equal payments over time.  Although the lump sum decreases in value, it still earns income on the unapportion balance.  This type of annuity is favored as a method of creating a monthly retirement income.

An example is, Paul has accumulated 400,000 and would like to know how much that would pay him each month for the next 30 years at interest rates at 5%.

So add it up.  By understanding the calculation of an annuity you can add up what you will benefit.