What Happens to an Annuity Deferred?
Deferred annuities are a type of annuity contract that delays payments to the investor until the investor elects to receive them. When the investor is in savings mode, he makes payments into some sort of investment account. The investment grows and compounds in a tax-deferred manner, and the investor pays no taxes on its growth until he decides to convert the investment into an annuity and start receiving regular payments.
You need to understand how to figure the future and present value of a deferred annuity for your intermediate accounting class. The good news is that you use the same method to figure the future value of a deferred annuity as when you calculate the future value of an ordinary annuity.
Future value of a deferred annuity
In 2013, Penway, Inc., starts planning for a major expansion in 2019. At the end of 2016, 2017, and 2018, Penway reckons that it will be able to invest $50,000 each year, earning 5 percent annually. How much money will Penway have to play with when it starts its expansion in 2019?
In this example, you have to ignore the first three years (2013, 2014, and 2015) because Penway has no plans to put aside any money during those years. You figure the value accumulated by using the standard formula for a future value of an ordinary annuity.
Checking out the preceding figure, you see that three years at 5 percent gives you a factor of 3.15250. Multiplying that factor by the amount saved per year of $50,000 gives you the future value of the deferred annuity, which is $157,625.
Present value of a deferred annuity
The present value of a deferred annuity tells you how much you need to invest today to achieve your desired savings result in the future. To accomplish this, you use just one different table: the present value of an ordinary annuity of 1.
Put this to work and make it personal! Suppose that you’re 18 years old. As an incentive to stay in school and get good grades, your Aunt Dottie says she’ll give you $3,000 a year for three years starting five years from now (after your proposed graduation date).
Given an annual interest rate of 5 percent and the total periods (which is seven — four years deferred plus three annual payments), you want to know the present value of the four payments.
Looking at the present value of an ordinary annuity of 1 table in your intermediate accounting textbook or online, you can see that the factor at the intersection of seven periods and 5 percent is 5.78637. Using the same table, you see that the factor at the intersection of four (deferred) periods and 5 percent is 3.54595.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
