How to Calculate Rate-of-Return on an Annuity

Investors should use a ROI calculation when evaluating the performance of an annuity and comparing 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, the annuity with the higher rate of return is preferable to one with a lower rate of return. This tutorial will demonstrate how to evaluate a single annuity. The point, of course, is to use this technique to evaluate two or more annuities and compare the results. This calculation can help answer questions such as: “Is annuity A generating a higher rate of return with a single payment amount, or is annuity B more favorable due to a higher initial payment followed by a reduced survivor benefit?” Several calculators on this site compute return on investment, but this one is by far the most flexible.

All users should work through the more detailed first tutorial to understand the Ultimate Financial Calculator’s (UFC) basic concepts and settings.

Assumptions: The annuity we are evaluating has an upfront cost of $1,500,000.00. It provides a monthly withdrawal of $8,775.00 for 20 years. After that, the withdrawal amount will be reduced to 65% of the original value due to the death of one spouse and will continue for an additional 10 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”. 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 for this series.

6. Create the third series. It will also be a “Withdrawal”:
   • This is where we assume the withdrawal amount will be reduced.
   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 that earns 5.2% annually, assuming simple interest. If an alternative investment compounds daily and the payment amounts do not change, then the effective ROI may be lower. Try that calculation to see the difference.

Back to the Ultimate Financial Calculator.