Then, use that payment amount in order to determine how much money will accumulate over a given number of periods. Because the annuity payments are made quarterly, we need to look at the fortieth period (10 years x 4) row until we find the factor (see the table above). An annuity’s future value is primarily used in computing premium payments of life insurance policy, calculation of monthly contribution to provident fund, etc. Future value is used for planning purposes to see what an investment, cashflow, or expense may be in the future.

There are several ways to measure the cost of making such payments or what they’re ultimately worth. Here’s what you need to know about calculating the present value (PV) or future value (FV) of an annuity. Most often, investors and analysts will know one value and try to solve for the other.

Relevance and Uses of Future Value of Annuity Due

For example, assume a $1,000 investment is held for five years in a savings account with 10% simple interest paid annually. In this case, the FV of the $1,000 initial investment is $1,000 × [1 + (0.10 x 5)], or $1,500. Valuation of life annuities may be performed by calculating the actuarial present value of the future life contingent payments. Life tables are used to calculate the probability that the annuitant lives to each future payment period.

Consequently, “future value of annuity” refers to the value of these series of payments at some future date. The formulas described above make it possible—and relatively easy, if you don’t mind the math—to determine the present or future value of either an ordinary annuity or an annuity due. Financial future value of annuity equation calculators (you can find them online) also have the ability to calculate these for you with the correct inputs. These recurring or ongoing payments are technically referred to as “annuities” (not to be confused with the financial product called an annuity, though the two are related).

Future Value of an Annuity

When you plug the numbers into the above formula, you can calculate the future value of an annuity. Here’s an example that should hopefully make it clearer how the formula works and what you should plug in where. To figure out the future value of your annuity, all you have to do is plug the relevant numbers into the above formula and follow the basic rules of mathematics. Remember to do the calculations inside of the parentheses first and then apply all exponents. Using the present value formula helps you determine how much cash you must earmark for an annuity to reach your goal of how much money you’ll receive in retirement. An annuity’s value is the sum of money you’ll need to invest in the present to provide income payments down the road.

For example, if an individual could earn a 5% return by investing in a high-quality corporate bond, they might use a 5% discount rate when calculating the present value of an annuity. The smallest discount rate used in these calculations is the risk-free rate of return. Treasury bonds are generally considered to be the closest thing to a risk-free investment, so their return is often used for this purpose. There will then be multiple time segments that require you to work left to right by repeating steps 3 through 5 in the procedure.

Lump Sum Vs. Annuity

Present value and future value simply indicate the value of an investment looking forward or looking back. The two concepts are directly related, as the future value of a series of cash flows also has a present value. For example, a present value of $1,000 today may be equal to the future value of $1,200 today. If a taxpayer knows they have filed their return late and are subject to the 5% penalty, that taxpayer can easily calculate the future value of their owed taxes based on the imposed growth rate of their fee. The future value formula could be reversed to determine how much something in the future is worth today. In other words, assuming the same investment assumptions, $1,050 has the present value of $1,000 today.

The discount rate reflects the time value of money, which means that a dollar today is worth more than a dollar in the future because it can be invested and potentially earn a return. The higher the discount rate, the lower the present value of the annuity, because the future payments are discounted more heavily. Conversely, a lower discount rate results in a higher present value for the annuity, because the future payments are discounted less heavily. The graph below shows the timelines of the two types of annuity with their future values. As you can see, in the case of an annuity due, each payment occurs a year before the payment at the ordinary annuity. The advanced payments immediately affect the future value of the annuity as the money stays in your bank for longer and therefore earns interest for one additional period.