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 over one with the lower rate of return. This tutorial will show you how to evaluate one annuity. The point, of course, is to use this technique to evaluate two or more annuities and compare the results. You can use this calculation to answer such questions as "is annuity "A" generating a higher rate of return with a single payment amount or annuity "B" with a higher initial payment amount and a lower payment amount paid to the survivor?" There are several financial calculators on this site that calculate return on investment, but the calculator 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 considering has an upfront cost of $1,500,000 and there will be a monthly withdrawal of $8,775 for 20 years and then the withdrawal will be reduced to 65% of the initial withdrawal amount (due to the death of one spouse) and payable for another 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" by clicking on {Settings} {Rounding Options}
  3. In the header section, make the following settings:
    1. For "Calculate Method" select "Normal".
    2. Set "Initial Compounding" to "Exact/Simple".
    3. Set "Initial Interest Rate" to "Unknown." Fig. 1
  1. 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 is the cost of the annuity, or the amount invested
    3. Set the "# 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
  1. Create the 2nd series. It will be a "Withdrawal"
    1. Enter the "Date" as December 1, 2024
    2. Enter the "Amount" as $8,775.00
    3. Enter 240 for "# Periods" (20 years of monthly withdrawals)
    4. Select "Monthly" for "Frequency"
      • Then "End Date" will be November 1, 2044. That is, the last withdrawal for this series will be on this date.
  1. Create the 3rd series. It will also be a "Withdrawal"
    • Here's where we assume the withdrawal will be reduced
    1. Enter the "Date" as December 1, 2044
    2. Enter the "Amount" as $5,703.75
    3. Enter 120 for "# Periods" (10 years of monthly withdrawals)
    4. Select "Monthly" for "Frequency"
      • Then "End Date" will be November 1, 2054
ROI calculation setup
Fig. 1 - Return on Investment (ROI) calculation set up.
  1. Click the [Calculate] button
    • The annualized result is "5.2%." Fig. 2
ROI calculation result
Fig. 2 - Return on Investment (ROI) result.

To replace this investment, you would need to find one that earns 5.2% assuming simple interest. If another investment compounded daily and the amounts didn't change, then the ROI could be less. Try that calculation to see for yourself.