How to Calculate Rate-of-Return on an Annuity

Investors should use a ROI calculation to evaluate the performance of an annuity and compare it to other investments. Return on Investment is defined at Wikinvest as:

a financial metric used to gauge the relative performance of an investment. It is basically the percentage of the original investment that has been returned to the investor as profit.

Ignoring risk, an annuity with a higher rate of return is more favorable than one with a lower return. This tutorial explains how to evaluate a single annuity. The same process can be used to evaluate and compare multiple annuities.

This calculation helps answer questions such as: “Is annuity A generating a higher return using a single payment amount, or is annuity B better because it has a higher initial payment followed by a reduced survivor benefit?” Several calculators on this website compute ROI, but this one is the most flexible available.

All users should first complete the more detailed first tutorial to understand the UFC’s basic concepts and settings.

Assumptions: The annuity being evaluated has an upfront cost of $1,500,000.00. It pays a monthly withdrawal of $8,775.00 for 20 years. After that, the monthly amount is reduced to 65% of the original amount due to the death of one spouse. Payments then continue for 10 additional years.

To calculate the return on investment, follow these steps:

1. Set Schedule Type to “Savings”.
   • Or click the New button to clear any previous entries.
2. Set Rounding to “Open balance—no adjustment”.
   Select Settings > Rounding Options.
3. In the header section, apply the following settings:
   1. Set Calculation Method to “Normal”.
   2. Set Initial Compounding to “Exact/Simple”.
   3. Set Initial Interest Rate to “Unknown”. Type u. Fig. 1

4. In row one of the cash flow input area, create a “Deposit” series:
   1. Set the Date to November 1, 2024.
   2. Set the Amount to $1,500,000.00.
      • This represents the cost of the annuity, or the total amount invested.
   3. Set # Periods to 1.
      • Note: Since the number of periods is 1, you will not be able to set a frequency. If a frequency is set, it will be cleared when you leave the row.

5. Create the second series. It will be a “Withdrawal”:
   1. Set the Date to December 1, 2024.
   2. Set the Amount to $8,775.00.
   3. Set # Periods to 240 (20 years of monthly withdrawals).
   4. Set Frequency to “Monthly”.
      • The End Date will be November 1, 2044. This is the date of the last withdrawal in this series.

6. Create the third series. It will also be a “Withdrawal”:
   • In this example, the withdrawal amount is reduced starting with this series.
   1. Set the Date to December 1, 2044.
   2. Set the Amount to $5,703.75.
   3. Set # Periods to 120 (10 years of monthly withdrawals).
   4. Set Frequency to “Monthly”.
      • The End Date will be November 1, 2054.

7. Click the Calculate button.
   • The annualized result is 5.2%. Fig. 2

To replace this investment, you would need to find another investment that earns 5.2% annually, assuming simple interest. If the alternative investment uses daily compounding and the payment amounts do not change, the effective ROI may be lower. You can perform that calculation to compare the results.

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