What is my rate of return on an immediate annuity?

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 note1} payments^{See note2See note,See note3} 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 note4}

• 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 note4}

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 note4}

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.