Personal Finance Annuities Bill Klinger

Personal Finance Review Disposable income Sources of cash outflows Savings rate Factors affecting cash flow Net worth Factors affecting net worth Time value of money Opportunity cost Present value Future value

Annuities Annuity – a series of payments Accumulation Calculate Illustrate Series of payment Calculate FVIFA FV = payment x FVIFA Table C.3

Annuities Problems You start at age 21 to save for retirement. You will invest $2500 each year in investments earning 8%. How much will you have when you retire at age 65? How much will you have at age 60? You wait until you are 35 to start saving for retirement. You will invest $2500 each year in investments earning 8%. How much will you have when you retire at age 65? How much will you have at age 60? You start at age 21 to save for retirement. You will invest $4000 each year in investments earning 8%. How much will you have when you retire at age 65? How much will you have at age 60? You wait until you are 35 to start saving for retirement. You will invest $4000 each year in investments earning 8%. How much will you have when you retire at age 65? How much will you have at age 60?

Annuities Problems What are the effects of You invest $3000 annually at 5% interest. How much will you have in 10 years? You invest $3000 annually at 7% interest. How much will you have? What are the effects of Longer times Larger annual payments Higher returns

Annuities Non-annual payments Monthly Semi-annual Problem Use 12x for number of periods Use 1/12 for interest Semi-annual Use 2x for number of periods Use ½ for interest Problem You save $100 out of your monthly check and invest it in an account earning an annual interest of 6%. How much will you have saved in 4 years?

Annuities Can also receive an annuity Calculate the PV of an annuity Pension Lottery Simple insurance annuity Social Security Calculate the PV of an annuity Illustrate, Show PVs PV = payment x PVIFA Use PVIFA from Table C.4 Problem You receive a pension of $30,000 a year. If interest rates are 5% and assuming you will live 35 more years, what is the value of that pension?

Annuities Problems Congratulations, you have won the lottery. You can choose to either take the cash value of $2M or take $200,000 a year for 20 years. Interest rates are 5%. Which should you take? Congratulations, you have retired early at age 60 (due to the good things you learned in this class). Your company will either pay you a pension of $30,000 a year for the rest of your life or pay you a lump sum of $450,000. Assume you will live to 95 and interest rates are 5%, which option should you choose? You are going to buy a house. You can afford to pay $30,000 a year for a mortgage. (Note: mortgages are paid monthly but the tables in C4 are not big enough to do that calculation. You know enough now to do this on a calculator or in Excel.) You can get a 30 year mortgage at 4%. How big a mortgage loan can you get?

Annuities Calculating the payments of an annuity Note that Similarly PVA = payment x PVIFA Then payment = PVA / PVIFA Similarly payment = FVA / FVIFA

Annuities Problems You want to buy a $300,000 home. You can put $30,000 down as a down payment and will need a mortgage for the rest. Assume annual payments for 15 years and an interest rate of 4%. What will be your annual payment? You want to have $2M when you retire in 30 years. Assume interest rates are 7%. How much do you have to save each year?

In Class In groups of two do Chapter 3 problem 16.