Annuity payments are calculated with a present-value formula that spreads your account balance across a set number of payment periods at an assumed interest rate. When the contract pays for life, the insurer swaps in an actuarial life-expectancy figure for that number of periods. The dollar amount you actually receive is then shaped by the payout option you choose, how long you deferred, the fees and riders baked into the contract, and, for indexed or variable products, the method used to credit interest along the way.
The Core Formula
Every fixed annuity payment traces back to one equation:
PMT = PV × [ r ÷ (1 − (1 + r)−n) ]
PV is your account balance at the moment payments start. r is the interest rate for each payment period. n is the total number of payments. The formula returns a slice of principal plus the interest that slice earned while it waited in the account, and by the final payment the balance reaches zero.
A concrete run-through: deposit $100,000, credit 5% annually, choose a 20-year monthly payout. The periodic rate is roughly 0.4167% (5% ÷ 12), and n is 240. The formula produces about $660 a month. Total collected over the 20 years is roughly $158,400, meaning about $58,400 came from interest credited on the shrinking balance.
That’s the clean case. When the contract promises to pay you for as long as you live, no one knows what n should be, and actuarial data steps in.
How Life Expectancy Shapes a Lifetime Payment
For a life annuity, the insurer replaces the fixed n with a statistical estimate drawn from mortality tables. Actuaries build those tables from population data showing how many people at each age are expected to survive another year. The company pools thousands of annuitants and prices payments so the numbers work across the whole pool, not for any one buyer.
Pooling creates mortality credits. When an annuitant dies earlier than the average, the money that would have funded their remaining payments effectively subsidizes those who live longer. That’s why a life-only payout is larger than a period-certain payout of the same expected length. You’re being compensated for the risk that you might die early and forfeit the balance.
Age and Gender
Age at the moment payments begin is the single biggest driver of check size. A 70-year-old converting $100,000 gets noticeably more each month than a 60-year-old with the same balance, because the insurer expects to write fewer checks in total. Gender matters too. As of early 2025, a 65-year-old man converting $100,000 into a single-life immediate annuity could expect roughly $644 per month, while a 65-year-old woman would receive about $616 from the same premium. The $28 gap reflects two to three additional years of expected payments for the woman.
Payout Options Change the Inputs
The payout structure you select reshapes what goes into the formula, so it reshapes what comes out.
Life Only
Payments run for as long as you live and stop the month you die. Nothing goes to heirs. Because the insurer keeps the balance in the event of an early death, this option produces the highest monthly income for a given premium. It’s mortality credits at full strength.
Period Certain
Payments last a guaranteed number of years, commonly 10 or 20, whether or not you’re alive to collect them. A beneficiary receives anything left if you die during the guarantee. The formula uses a fixed n with no actuarial adjustment, which is why monthly income is lower than life-only.
Joint and Survivor
Payments continue for two lives, usually spouses. When the first person dies, the survivor keeps receiving income at 100%, 75%, or 50% of the original amount, depending on the election. Two lifespans stretch the same money further, so initial payments are meaningfully lower than a single-life payout. Using the same early-2025 data, a 65-year-old couple converting $100,000 into a joint-life immediate annuity would receive around $558 per month, compared with $644 for the single male life-only payout.
Cash Refund and Installment Refund
These options guarantee that you or a beneficiary will receive at least what you paid in. A cash refund pays the shortfall in a lump sum if you die before recovering your premium. An installment refund keeps the regular checks going to the beneficiary until the premium is recovered. Both cost more than life-only because the insurer gives up the mortality credits from early deaths, typically dropping the payout rate by several tenths of a percentage point.
Immediate Versus Deferred Timing
With an immediate annuity, you hand over a lump sum and payments begin within 30 days. The PV feeding the formula is essentially your deposit. A deferred annuity lets the money compound for years or decades first. A $100,000 deposit growing at 4% for 15 years becomes roughly $180,000 before the first payment is ever calculated, and that larger PV drives a larger check.
Distribution frequency nudges the math too. Monthly is most common, but quarterly or annual options leave money in the account longer between payments and let a bit more interest accrue. The effect is small in practice but real.
How the Credited Rate Gets Set
The r in the formula is straightforward for a traditional fixed annuity: the insurer credits a stated rate. Indexed and variable contracts determine that rate differently, which changes the account value that eventually feeds into the payout calculation.
Fixed Indexed Annuities
Credited interest is tied to a market index (often the S&P 500), subject to contractual limits that cap the upside and protect the downside. Three limits do most of the work:
- A cap rate ceilings the interest earned in a period. A 15% index gain against an 8% cap credits 8%.
- A participation rate credits only a percentage of the index gain. An 85% participation rate on a 10% gain credits 8.5%.
- A spread subtracts a flat percentage from the index return before crediting. A 4% spread on a 6% gain leaves 2%.
Some contracts stack these. A 90% participation rate with a 3% spread would credit 6% on a 10% index gain: (10% × 90%) − 3% = 6%. The insurer can adjust caps, participation rates, and spreads at each policy anniversary, so the credited interest feeding the eventual payout shifts from year to year. A guaranteed minimum floor, typically 0%, keeps index losses from cutting into the account value.
The indexing method also matters. A point-to-point method compares the index at the start and end of a full term, often a year. An annual reset method measures gains within each individual year and locks them in, so a bad year can’t erase prior credits. The method changes when gains are captured, which changes the accumulated value that later runs through the payment formula.
Variable Annuities
Variable annuities work differently. Your money goes into investment subaccounts that resemble mutual funds, and during accumulation the balance rises and falls with the market.
When you annuitize, the insurer sets an assumed investment rate, or AIR, as the benchmark for calculating your first payment. That payment is computed as if the subaccounts will earn the AIR every year going forward. Each subsequent payment then adjusts up or down based on whether actual returns beat or trailed the AIR. Beat it, and the next check rises. Miss it, and the next check falls.
A higher AIR produces a larger initial payment but makes it harder for actual returns to keep up, so future payments are more likely to decline. A lower AIR starts smaller but gives the market more room to exceed the benchmark, so income is more likely to grow over time.
Fees and Charges That Shrink the Balance
The formula operates on your net account value after fees. Four charges do most of the erosion:
- The mortality and expense (M&E) risk charge covers the insurer’s cost of guaranteeing lifetime income and assuming longevity risk. For variable annuities it typically runs around 1.25% of account value per year. Fixed annuities bake this cost into the credited rate rather than itemizing it.
- Administrative fees cover record-keeping, commonly $30 to $100 per year, and some insurers waive the charge once the balance passes a threshold.
- Investment management fees on variable annuity subaccounts often run 0.5% to 1.5% annually, layered on top of the M&E charge.
- Agent commissions of roughly 1% to 8% of premium don’t show up as a line-item deduction, but the insurer builds the cost into product pricing and the surrender schedule.
State premium taxes, typically 1% to about 2.35% of the premium depending on the state, may also apply at purchase. They aren’t recurring, but they reduce the initial deposit that goes to work.
Surrender charges apply if you withdraw money in the early years of a deferred annuity. A typical schedule starts at 7% in year one and steps down a point each year to zero by year eight, with most contracts allowing up to 10% of the account value out each year without penalty. Immediate annuities generally can’t be surrendered, so this concern applies only to deferred contracts.
Riders That Trade Payment Size for Extra Guarantees
Riders add promises to the base contract, and each one adjusts the payment because the insurer has to reserve funds for the extra guarantee.
A cost-of-living adjustment rider increases payments each year by a set percentage or by an inflation index. The trade-off is a noticeably lower starting payment, because the insurer front-loads less income so it can ramp payments up later without running out of money.
A death benefit rider guarantees a beneficiary receives at least a minimum (often original premium minus withdrawals) if you die during accumulation. The annual fee is deducted from the account value, which reduces the balance available when payments eventually begin.
Guaranteed lifetime withdrawal benefit riders let you take a set percentage of a benefit base each year for life without formally annuitizing. The benefit base may reset upward after strong performance years. Annual fees often range from 0.75% to 1.25% of the benefit base, compounding against your account value and meaningfully reducing the balance available for future income.
What You Keep After Tax
The gross check the insurer sends is one number; what lands in your bank account is another. Tax treatment depends on whether the annuity is qualified or non-qualified.
Non-Qualified Annuities and the Exclusion Ratio
If you bought the annuity with after-tax money, the IRS splits each payment during annuitization into a tax-free return of your investment and taxable earnings using the exclusion ratio. Divide your investment in the contract by your expected return over the payout period. If you invested $100,000 and the expected return under actuarial tables is $200,000, the ratio is 50%, so half of every payment is tax-free and half is taxable ordinary income. Once you’ve recovered your full investment, subsequent payments are fully taxable.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts IRS Publication 939 walks through the step-by-step calculation, including the actuarial tables used to figure expected return for a life annuity.2Internal Revenue Service. Publication 939, General Rule for Pensions and Annuities
If you die before recovering your full investment, the unrecovered amount can be claimed as a deduction on your final tax return.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
Qualified Annuities
Annuities held inside an IRA or funded with pre-tax 401(k) rollovers are fully taxable on every dollar distributed. No after-tax investment was made, so there’s no exclusion ratio. Every payment is ordinary income.