Annuity Values

All About Annuities and Their Values

(Because you should know what to expect from your retirement investments)

Jeffrey Green | January 8, 2020
Annuity Values

As you know, annuities are a great, secure way to invest your money for your retirement years. And depending on the type of annuity you choose to invest in, your return will vary. So how are you supposed to know which to choose, and what the value of your annuity is? That's where having an independent insurance agent in your corner is always a good idea.

Independent insurance agents are experts in the field of annuities and all insurances who can answer all your questions to help pair your goals, needs, and budget with the right annuity option for you. They'll help find the best rates and companies for your situation and walk you through every step of the way. It just doesn't get any easier than that. But first, here's a bit of background on all types of annuities and their values to help get you started.

First Things First — What’s an Annuity?

Annuities are policies issued by insurance companies. They pay a regular guaranteed income for life or a period of years. You buy an annuity policy by making a single payment or a series of payments.

  • Deferred annuities accumulate money for a period of time before the policy pays income. 
  • Immediate annuities start paying income right away.
  • Qualified annuities are part of a pension plan or IRA. They are purchased with before-tax dollars. Qualified Roth annuities are part of a Roth IRA or pension plan. They are purchased with after-tax dollars. Non-qualified annuities are personally owned and paid for with after-tax dollars.

Deferred Fixed Annuity Values

Fixed deferred annuities accumulate money at a stated rate of interest. The values of a fixed annuity are guaranteed by the insurance company. The guarantees apply to:

  • The cash value: The payments accumulated at the interest rates applied. The cash value is the total money at work.
  • The surrender value: The cash value minus any charges for cashing in the policy. The surrender value is the money available to you.
  • Death benefit:  This is the minimum value your beneficiaries receive.

Deferred Fixed-Indexed Annuity Values

Fixed-indexed annuities offer growth potential without stock market risk. Index accounts credit some of the gains of a market index like the S&P 500 and none of the losses. The portion of gains credited are measured by a formula. The values of a fixed-indexed annuity are guaranteed by the insurance company. The guarantees apply to:

  • The cash value: The payments and interest credits applied. The cash value is the total money at work.
  • The surrender value: The cash value minus any charges for cashing in the policy. The surrender value is the money available to you.
  • The minimum surrender value: The lowest amount you will receive if you surrender the policy.
  • Death benefit: The minimum value your beneficiaries receive.

Deferred Variable Annuities

Deferred variable annuities accumulate money in investments selected by the owner called subaccounts. Like mutual funds or other investments, the value of the subaccounts is based on market performance. They aren’t guaranteed. 

  • The account value: This is the purchase payments and investment growth. The account value is the total money at work. 
  • The surrender value: This is the account value minus any surrender charges. The surrender value is the money available to you.
  • Death benefit: This is the minimum value your beneficiaries receive.

Immediate Annuity Values

Immediate annuities and deferred annuities make regular payments in the income phase to the owner for a period of time. Some insurance companies will allow an owner or beneficiary to stop the payments in exchange for a lump sum of money. The amount of the lump sum is called the commuted value. It's the present value of all the future payments at an assumed rate of interest called the discount rate.

There are also factoring companies that buy annuity payments and they use the same process. The price that they offer is determined by the discount rate that they use. The higher the discount rate, the lower the price offered. 

Determining the Value of an Annuity

Now that you understand the basic types of annuities, one of the most common questions asked about them is, "How much money is an annuity worth?"

Consult the Prospectus

To get the answer, speaking with the independent insurance agent who issued the annuity can help dispel some of the guesswork involved. Beforehand, you're legally entitled to receive a rundown of the annuity called the prospectus. The prospectus is an official document that contains important information about the annuity contract including fees and charges, investment options, death benefits to your beneficiaries, payout options and more. By going over the prospectus with an independent insurance agent, you can get a clearer picture of how much an annuity will payout in real-world circumstances.

Adjusting for Fees and Charges

It should be said that annuities are complicated investment vehicles due to the amount of fees and charges added into the annuity contract. Depending on the riders, term of the contract, and other variables, you may have to calculate for the following:

  • Management fees
  • Front-end fees
  • Mortality and expense risk charge
  • Surrender charges
  • Administrative charges
  • 12b-1 fees
  • Death benefits
  • Guaranteed Minimum Income Benefit (GMIB) 
  • Guaranteed Minimum Accumulation Benefit (GMAB) 
  • Guaranteed Minimum Withdrawal Benefit (GMWB) 
  • Guaranteed Lifetime Withdrawal Benefit (GLWB) 
  • Long-Term Care (LTC) benefits
  • Standalone Living Benefit (SALB)
  • And more

Understanding the Investment's Performance

It becomes complicated to determine an annuity's value when interest rates and the performance of underlying investments are taken into account. For example, if you have an immediate variable annuity, you will receive monthly/annual payments that vary depending on whether an index performs well or poorly over the course of several years. 

There are some factors to consider based on the investment's performance:

  • Guaranteed payouts: Annuities are used as investment vehicles to protect the principal of the investor. Because of this, many fixed annuities offer guaranteed payouts that can grow in accordance with inflation and as a way to minimize risk.
  • Interest rate caps: For variable annuities, many insurers limit the amount that an annuity can grow for an investor. While caps tend to be high — generally above 10% — if the investments outperform the rate cap, the investor will only receive the capped amount.  This means that, if an index performs at 17% during the term with a 13% interest rate cap, the investor may miss out on the 4% growth that other investment vehicles, such as mutual funds, may offer.
  • Participation rate:  For fixed-indexed annuities, which combine fixed and variable aspects of each type, investors are able to enjoy the profits to top-performing stocks while receiving guaranteed payouts. However, the amount that is returned to the investor is based on the participation rate. In essence, the participation rate is a percentage of a percentage. For example, if a stock realizes 10% in growth with an 80% participation rate, the annuity will only payout 8%. In most cases, participation rates decline the longer an annuity is held, typically going down to around 20% after several years of owning the annuity.

When is the Annuity Worth the Most? Or Least?

In most cases, annuities are investments that come with some degree of risk to the policyholder:

  • Early withdrawal: Most annuities allow for some liquidity when it comes time to withdrawing money from the account. Generally, this is up to 10% of the annuity's value within the first five to seven years of owning the policy. Any amount over that will be penalized a percentage of the surrender value, which could be as high as 20%. Also, withdrawals of an annuity before a person reaches 59 1/2 will be responsible for a 10% fee paid to the IRS, as well as the withdrawal amount being classified as income. 
  • Tax liability: Annuities are a tax-deferment investment, which means that you don't pay taxes on the principal until taking withdrawals. Instead, annuity payout is considered income, which you'll be responsible for paying on your income taxes.  However, receiving a lump-sum settlement is counted as part of the recipient’s income, which can have significant repercussions on your tax liability. This means that you may be elevated into a higher tax bracket, which comes with large taxes. Beneficiaries who receive a lump-sum payout from an annuity are also responsible for paying income taxes, which can make the value of the annuity seem much lower.
  • Market downturn: For annuities that are tied to the market, a significant downturn in the market can actually reduce the value of the annuity, especially during prolonged periods of poor performance. Variable annuities are especially susceptible to this, whereas other annuities offer some form of principal protection to protect your investment.

If you’re confused about how much a particular annuity may be worth to you in the future, or how your current annuities may offer, speak with an independent insurance agent to get a clear picture. Independent agents are able to break down and precisely detail how much you can expect to earn in the future, whether other insurance products are more beneficial to your retirement strategy, and more.

Calculating the Value of an Annuity

If you're looking to calculate the value of an annuity, you'll need some simplified annuity formulas. With the formulas below, you'll be able to better understand whether an annuity is a worthy investment for receiving regular annuities or whether the option of receiving a lump-sum payment at a later date is a viable option. 

Calculating the Present Value of an Annuity

The present value of an annuity is the cash value of all of your future annuity payments. The rate of return or discount rate is part of the calculation. An annuity’s future payments are reduced based on the discount rate. Thus, the higher the discount rate, the lower the present value of the annuity is.

The present value of an annuity is based on the time value of money. You can invest money to make more money through interest and other return mechanisms, meaning that getting $5,000 right now is more valuable than being promised $5,000 in five years. The rate of return you’ll earn from investing that $5,000 means that by the time you would get the $5,000 in five years, the $5,000 you would get now would be worth more money.

Formula for the Present Value of an Annuity

The simplified formula to determine the present value of an annuity is:

Annuit rate formula

Where:

  • P = the present value of annuity
  • PMT = the amount in each annuity payment (in dollars)
  • r = the interest or discount rate
  • n = the number of payments left to receive

Example: Determining the Present Value of an Annuity

As you can imagine, the math can get tricky if you're unfamiliar with how much your annuity is worth, how many payments are remaining, and so forth. 

Here is an example of a regular annuity.

Suppose you have the option of receiving either:

  • a lump sum of $300,000, or
  • a $25,000 annuity for 20 years with a discount rate of 5%

Let's plug these numbers into the formula for the present value of the annuity:

P = ? 

PMT = $25,000

r = 5% = .05

n = 20 years

P = 25,000 x ((1 – (1 / (1 + .05) ^ -20)) / .05)

Solving for P, the total comes out to $311,555. 

In essence, this gives you the choice of choosing a $300,000 lump sum or choosing regular payments that total more than $11,555 over 20 years.

Calculating the Future Value of an Annuity

If you've managed to follow the math for present value of annuity, then you should know that determining the future value of an annuity is a bit more involved and less precise, especially when considering variable annuities. Nevertheless, here's the simplified formula:

Formula for the Future Value of an Annuity

  • P = the payment amount
  • I = the interest or discount rate
  • N is the number of payments 
  • F is the future value of the annuity

Example: Future Value of an Annuity

Suppose an annuity pays $500 annually for 10 years.  The discount rate is 6%.

Therefore:

P = $500

I= 6%, or .06

N = 10 years

F = ?

F= $500 * ([1 + 0.06]^10 - 1 )/0.06. 

This means that the future value works out to $6,590.40, which factors out to $5,000 in payments plus $1,590.40 in interest.

So What's Next?

If you're considering purchasing an annuity, and want to talk over your options in more detail, get in touch with an independent insurance agent. They'll know just how to help you with all your annuity questions.

Benefits of an Independent Insurance Agent

Independent insurance agents are experts at helping make sense of the ins and outs of all types of annuities and other financial tools. They have access to multiple insurance companies, ultimately finding you the best coverage, accessibility, and competitive pricing while working entirely for you. And in the end, you'll be all set with the perfect retirement investment to match your needs, goals, and budget.

TrustedChoice.com Article | Reviewed by Neal Lane

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