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What is rate of return on an immediate annuity?

Comparing immediate annuities to other investments can be confusing and misleading. Let's clear up some of the confusion and help you make the best choice for your retirement savings.

Article:

Updated: Published:

Robert Steen, Ph.D., CFP® Reviewed by: Editorial contributors

Note:

Information courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York.

 

Some people interested in annuities may ask about the rate of return, or the net gain or loss over time, of an immediate annuity. It's a fair question. But the answer is complicated because an immediate annuity, sometimes called an income annuity, isn't the same as a typical investment.

Annuities are structured to provide regular, guaranteed‍ ‍ See note 1 payments‍ ‍ See note 2 during retirement. When you buy an annuity, your goal isn't to maximize your return. It's to make sure you don't outlive your assets.

With that said, there are ways to evaluate an immediate annuity and determine its rate of return.

Helpful calculations

Here are several common calculations you can use to evaluate immediate annuities. We've also included brief descriptions of how they work and links to online tools that'll do the math for you.

1. Calculate present value, or PV.

This is how much money you'd need today to fund a series of future payments.

To make the calculation, you need three values, and you can use an online PV calculator (Opens in new window).‍ ‍ See note 3

  • The periodic payment amounts
  • A constant rate of return
  • The number of payments

The goal here is to see if you'd be better off receiving the PV in a lump sum today, or as cash flow over time.

2. Calculate future value, or FV.

Another way to evaluate an immediate annuity is to look at the value of its cash flow in the future, instead of the present. You use the same inputs as the PV calculation. In this case, the goal is to see if you'd be better off receiving a lump sum at a future date or receiving cash flow over time. Again, there is an online tool to do the math for calculating FV (Opens in new window).‍ ‍ See note 3

3. Calculate the internal rate of return, or IRR.

Using this calculation, also known as the annualized rate of return, you're trying to find the interest rate that makes the annuity's present value equal to the amount you paid for the annuity. Basically, the IRR measures the annuity's cash flow to determine its rate of return (Opens in new window).‍ ‍ See note 3

Spoiler alert: The IRR will probably range from negative to zero for the first 20 years or so. Eventually, it'll turn positive. But it'll still feel small in comparison to other investments.

While the IRR calculation comes the closest to finding a true rate of return, each calculation has its shortcomings. All three require you to input the number of payments, which is hard to predict. Unless you're buying a fixed annuity for a set period, you can't know the number of payments because you don't know how long you'll live.

So, if an immediate annuity's rate of return is so hard to determine, how should you measure its value?

Think of an immediate annuity as insurance.

Immediate annuities aren't truly investments. They're insurance products. And they're one of the few products available that offer guaranteed protection for your retirement income needs. People buy immediate annuities because they guarantee you won't run out of money, not because of the rate of return.

When planning for income to meet your basic needs, you should focus on solutions that provide certainty, like annuities, rather than investments. Investments can be great for growth and combating inflation. But they usually can't offer the guarantee of income for as long as you live. Immediate annuities are uniquely designed to help you get the money you'll need for a long life.

Make sure to consider your own needs and circumstances when looking for retirement solutions. If you want more information before deciding how to use your money, read more about the differences between annuities and investments.

Think an annuity may be the right choice for you?

Explore what USAA has to offer.

Learn more about annuities

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Related footnotes:

  1. Guarantees apply to certain insurance and annuity products and are subject to product terms, exclusions and limitations and the insurer's claims-paying ability and financial strength.

  2. Money not previously taxed is taxed as income when paid. Withdrawals before age 59½ may be subject to a 10% federal tax penalty.

  3. You are leaving USAA and being directed to a third party site that is not maintained, owned or operated by USAA. USAA does not control and is not responsible for the site content or the privacy or security practices of third parties. You should read the third party's privacy and security policies and site terms, as their practices may differ from those of USAA.

Related footnotes:

  1. An annuity is a long-term insurance contract issued by an insurance company designed to provide a retirement income stream for life. Once the contract principal is converted into an income stream, you will no longer have access to your principal as a lump sum. Terms, conditions, limitations and surrender charges may apply.

  2. Life insurance and annuities provided by USAA Life Insurance Company, San Antonio, TX and in New York by USAA Life Insurance Company of New York, Highland Falls, NY. All insurance products are subject to state availability, issue limitations and contractual terms and conditions. Each company has sole financial responsibility for its own products.

  3. Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.

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