Overview
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Calculates the annual, year-end value of an investment if either: the amount of each annual contribution is increased or the specified rate of return on investment is increased.
In this article:
Background
Among the most important time value calculations available to the financial planner is the "growing annuity." Through this mathematical concept, it is possible to determine how much a client will have in a fund at the end of each year, if he earns more than a given rate on his investment or he increases the level of his investment each year.
For example, your client wants to accumulate $100,000 over ten years to send his eight year old twin daughters to college. He feels confident he can earn a seven-percent rate of return (after taxes). Based on past pay raises, he also believes that he will be able to increase his contributions by the same percentage as his annual pay increases six percent each year. Using this steady return of an annually increasing contribution, he'll only need to start with $5,672. If he earns seven percent on the invested funds, and increases each succeeding annual contribution by just six percent, he'll reach his $100,000 goal on time.
Representatives should caution clients to express the target amount ($100,000 in the example above) in terms of future rather than present dollars. In other words, if the client feels he needs $100,000 based on the purchasing power of today's dollars, but also expects inflation between now and then to increase college costs by seven percent per year, the target should not be $100,000 but rather $196,715. This is determined by calculating the future value of $100,000 in ten years at seven percent. (The Future Value of a Lump Sum calculation can be used to calculate this figure.)
Retirement planning also requires an understanding of the growing annuity concept. For instance, assume your client is a participant in a 401(k) plan. Contributions on her behalf are based on a percentage of her salary. If she contributes six percent of her current salary, and her employer matches that amount 50 cents for every dollar, how much will she have when she retires (Factoring in 402(g) limits to deferrals if applicable). If you expect her salary to increase each year by some constant rate, both the employee's and the employer's contributions are forms of growing annuities to the fund. If there is currently a balance in the plan account, the future value of that account must be computed separately using the Future calculation (from the Estate Planning Tools) with that result added to the future value computed for the growing annuity.
Why should I use this calculator?
- To determine what the value of a retirement plan will be, if each year increasing contributions are made.
- To illustrate how a client can reach a given goal with less risk by having a steady annual increase in contribution.
- To show a client that a modest increase in net return on a retirement (or college) fund, coupled with a slight increase in the rate at which contributions are made, will combine for a dramatic increase in the future value of the fund.
Getting Started
Among the most important time value calculations available to the financial planner is the "growing annuity." Through this mathematical concept, it is possible to determine how much a client will have in a fund at the end of each year, if he earns more than a given rate on his investment or he increases the level of his investment each year.
For example, your client wants to accumulate $100,000 over 10 years to send his 8-year-old twin daughters to college. He feels confident he can earn a seven percent rate of return (after taxes).Based on past pay raises, he also believes that he will be able to increase his contributions by the same percentage as his annual pay increases six percent each year. Using this steady return of an annually increasing contribution, he'll only need to start with $5,672. If he earns seven percent on the invested funds, and increases each succeeding annual contribution by just six percent, he'll reach his $100,000 goal on time.
Planners should caution clients to express the target amount ($100,000 in the example above) in terms of "future" rather than "present" dollars. In other words, if the client feels he needs$100,000 based on the purchasing power of today's dollars, but also expects inflation between now and then to increase college costs by seven percent per year, the target should not be $100,000but rather $196,715. This is determined by calculating the future value of $100,000 in 10 years at seven percent. The Future Value of a Lump Sum calculation (under Estate Planning Tools) can be used to calculate this figure.
Retirement planning also requires an understanding of the growing annuity concept. For instance, assume your client is a participant in a 401(k) plan. Contributions on her behalf are based on a percentage of her salary. If she contributes six percent of her current salary, and her employer matches that amount 50 cents for every dollar, how much will she have when she retires (Factoring in 402(g)limits to deferrals if applicable). If you expect her salary to increase each year by some constant rate, both the employee's and the employer's contributions are forms of growing annuities to the fund. If there is currently a balance in the plan account, the future value of that account must be computed separately using the Future calculation (from the Estate Planning Tools section) with that result added to the future value computed for the growing annuity.
Entering Data
- Future Value: Enter the desired future value of the investment.
- Accumulation Period (Years): Enter the number of years that payments will be made.
- After-tax Return on Invested Capital: Enter the after-tax return on the invested capital.
- Annual Percentage Increase: Enter the rate by which the contributions following the initial contribution will increase per year.
Results
The program will calculate the annual future value of the investment fund at the assumed earnings rate and rate of increase in future contributions.
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