When markets are turbulent and recession rears its ugly head, investors can turn to annuities to help assuage their concerns that their retirement funds could run out. These investing vehicles can offer a steady, predictable source of income over the long term.
But how much does an annuity pay per month? That depends on the type of annuity you have, the payout duration and the principal investment.
How Annuities Work
An annuity is a contract between you and an insurance company. When you buy an annuity, the insurance company is required to make payments to you, either right away or at some specific point in the future. In exchange, you make premium payments, either as a lump sum or in installments.
Annuities themselves are either immediate or deferred:
- Immediate. With an immediate annuity, the annuity is purchased with a one-time contribution, and the annuity provides income payments to the annuitant within one year of its purchase.
- Deferred. Deferred annuities can be purchased with one-time contributions or installments, and they provide income to the annuitant at a future date.
According to Melody Evans, a wealth manager advisor with TIAA, annuities can be appealing because they provide periodic payments in retirement.
“Annuities provide certainty,” she says. “Fixed annuities can provide a known and stated crediting rate and annuity payouts provide a known and stated monthly payment.”
You also pay no taxes on the income and investment gains until you start taking withdrawals. In this way, annuities offer tax-deferred growth.
How to Calculate Your Monthly Annuity Payout
Before purchasing an annuity, you likely want to know how much you can expect in monthly payouts.
According to Misty Garza, a certified financial planner and vice president with Bogart Wealth, annuity payments vary based on several factors.
“Annuity payments are a function of the individual’s age, current mortality tables, current interest rates, and how much they are putting into the annuity,” she says.
Although there are three main types of annuities—variable, indexed and fixed—for demonstration purposes we’ve focused on calculating the monthly payouts offered by fixed annuities.
With a fixed annuity, the insurance company guarantees the payout will be the principal and a minimum rate of interest. As long as the insurance company you choose is financially stable, the money that you have in a fixed annuity will grow, and it will not drop in value.
To calculate your payouts, consider the following variables:
- Principal balance. The principal of your annuity is how much you paid to purchase it. You may have purchased it with a lump sum or installment payments; the principal is the total you contributed, minus any fees or charges. The higher your principal, the higher your monthly payment.
- Interest rate. Fixed annuities have a minimum rate of interest, so the interest rate will never fall below that number. The minimum rate should be listed on your annuity statement or contract.
- Payout schedule. Some annuities pay you in installments for a specific period, such as 10 years, while others may give you installment payments for your lifetime. The payout schedule will affect if you even receive a payment every month.
- Inflation. Price increases throughout the economy slowly erode the purchasing power of your annuity payments. Some annuities offer optional inflation protection riders, which could decrease the amount of your initial monthly payout but preserve the value of ongoing payments over the long term.
Annuity Payout Formula
The formula to calculate your annuity payout is:
P = (d[1-(1 + r/k)-nk])/(r/k)
- P: Balance of the annuity at the beginning of the payout period
- D: The regular withdrawal amount
- R: Annual interest rate in decimal form
- K: The number of compounding periods; since we are calculating monthly payouts, we used 12
- N: The number of years you plan to take withdrawals
Assuming a $100,000 one-time contribution, a 4% interest rate and a 10-year payout period, here’s how to calculate your monthly payouts:
$100,000 = (d[1-(1 + 0.04/12)-10*12])/(0.04/12)
Using that formula, you can find your monthly payout with different terms:
If math is not your strong point, or if you’re simply looking for a faster method, you can use any number of online annuity payout calculators.
Annuities and Retirement Planning
In general, experts recommend that annuities complement your retirement savings, but they shouldn’t make up your entire plan.
“Annuities have their place for certain individuals, but they are not meant for everyone,” Garza says. “I think it is important to understand one’s risk tolerance and comfort level with the market to determine whether or not they will be better off with an annuity for an income stream.”
When considering whether an annuity is right for you—and how large of one to purchase—keep in mind that annuities lock up your cash.
“The biggest [drawback] is no longer having a larger pot of money to draw from should you have a major expense come up,” Garza says. “Because of this, it is important to make sure you do not put all your money into the annuity.”
Unlike bank accounts, annuities aren’t insured by the government through the Federal Deposit Insurance Corporation (FDIC). As you consider your options and weigh the pros and cons of annuities, consulting with a financial advisor can help you create a plan that works for you.
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