An annuity is an agreement in which an individual agrees to receive periodic payments from an insurance company or government. The monthly payments are based on a variety of factors. They may include the life expectancy of the person writing the checks, their age at the time of signing the agreement, or some other statistical feature. Once written, an annuity remains in effect until the agreed upon death or withdrawal. In most cases, an annuity provides a lump sum payment that is substantially less than the face value of the annuity or the amount expected to be received thereon.

Because of the way in which they are paid out, annuities are known as “per annum” plans. The present value of an annuity essentially is the amount of money that would be available to receive a single payment in the future if the person were to still be living. The higher the discount rates, the more substantially the present value of the annuity will be when the person dies. Discount rates are most commonly in a range of ten to twenty percent.

There are two specific mathematical formulas used to determine the value and benefit of annuities. One is the FMV, or Fair Market Value, and the other is the present day value, or the redeem rate. These formulas are complex and are used only by financial planners and insurance agents who handle these types of financial transactions on a daily basis.

The benefit of annuities, in terms of taxes received, is determined by using both the fair market value and the present day values of the periodic payments. Fair market value is defined as the price that the asset would sell for if someone were to sell it to a willing buyer at the current time. The present day value is the amount that the annuitant would receive if he or she were to sell the annuity for cash today. These two concepts are used to calculate the lifetime and early distribution fees that are charged on annuities. Lifetime and early distributions are not included in the equation because life expectancy is not part of retirement income.

The final step of the formula to determine the value of annuities is to find the start and end date of the investment. The start date is the date of purchase and the end date is the date of sale or purchase withdrawal. Using the present day value or the fair market value allows for an investor to calculate his or her annual return on investment. The start date should be after the first year of membership, while the end date should be after the fifth year of membership. Some annuities have restrictions on the start and end date and these restrictions must be met before the annuity can be sold.

There are different terms that are used in annuities but the basics of these key terms are the same in all annuities. In addition, there are some other terms not explained here such as accrued principal, accrued interest, original premiums, modified payments, tax-qualified annuities and guaranteed annuities. These key terms will be explained more in depth as time goes by. Annuity pricing is based on assumptions and these assumptions can change over time. However, investors need to understand that when these assumptions change, their returns and risk level will also change.