Present Value of an Annuity

Understanding the Present Value of an Annuity Understanding the present value of an annuity allows you to compare options for keeping or selling your annuity. Breaking Down the Present Value of an Annuity The present value of an annuity is influenced by the interest rate employed to discount future payments, the number and size of payments and the timing of those payments. This value is also based on the time value of money - the idea that a certain amount of money is worth more today than it will be tomorrow. The Formula: PVOA = PMT * [(1 − (1 / (1 + r)^n)) / r] • PVOA is the present value of the annuity stream • PMT is the dollar amount of each payment • r is the discount or interest rate • n is the number of periods in which payments will be made Calculating the Present Value of an Annuity Present value calculations are influenced by when annuity payments are disbursed - either at the beginning or the end of a period. These are called "ordinary annuities" if they are disbursed at the end of a period, and an "annuity due" if payments are made at the beginning of a period. These calculations have their own formulas that should be referenced. EXAMPLE: Your structured settlement pays you $1,000 a year for 10 years. If you keep all your payments, you will eventually receive $10,000. Let's assume you want to sell five years' worth of payments, or $5,000, and the factoring company applies a 10% discount rate. This means... • PMT= $1,000 •r = 10%, represented as 0.10 • n = 5 (one payment each year for five years) Why Is Knowing the Present Value of an Annuity Important? Knowing the present value of an annuity allows you to understand the value of your future payments, better evaluate offers to sell your annuity, make retirement and financial decisions easier, and understand your tax implications.