5.5 Calculating the Term of an Annuity

When saving up for future goals, many people and businesses simply determine how much they can afford to invest each time period and then try to be patient until they meet their savings goal. What they do not know is how long it will take them. For example, if you can put $75 per month into your vacation fund, how long will it take to save up the $1,000 needed for a spring break vacation in Puerto Vallarta? How long it takes to fulfill the goal of your annuity depends on your annuity payment, interest rate, and the amount of money involved.

You must calculate the number of annuity payments, and the corresponding term, in a variety of scenarios such as:

• Savings planning.
• Debt extinguishment.
• Sustaining withdrawals from an investment.

Using a Financial Calculator

Although it is possible to find the number of payments by using the appropriate future value or present value formula, it is much more practical to use a financial calculator.  You use the financial calculator in the same way as described previously, but the only difference is that the unknown quantity is N (the number of payments in the annuity).  You must still load the other six variables into the calculator and apply the cash flow sign conventions carefully.

Finding the Term

The value of N is the number of payment periods for the annuity, after the value obtained from the calculator is rounded up to the next whole number.  For example, N=8.3174 means that there are 9 payments in the annuity.  N does not represent the time period or term.  Because, [latex]N=P/Y \times t[/latex], where [latex]t[/latex] is the time in years, the number of years can be found by

[latex]\displaystyle{\mbox{Number of Years}=\frac{\mbox{rounded up value of }N}{P/Y}}[/latex]

The whole number portion of the number of years (the part on the left-side of the decimal) represents the number of years. As needed, take the decimal number portion (the part on the right-side of the decimal point) and multiply it by 12 to convert it to months.

NOTES

1. To determine the term of the annuity, the value of N must be calculated first.
2. In annuity calculations, the value of N is rounded UP to the next whole number before converting to years and months.
3. Because the value of N is rounded up to the next whole number, the last payment in the annuity will typically be smaller than the other payments.  In a later section, you will learn how to calculate the size of the last payment.

EXAMPLE

Samia has $500,000 accumulated in her retirement savings when she decides to retire at age 60. If she wants to receive beginning-of-month payments of $3,000 and her retirement annuity can earn 5.2% compounded monthly, how old is Samia when the fund is depleted?

Solution:

The timeline for the retirement annuity appears below.

Step 1:  Calculate the value of N.

PMT Setting	BGN
N	?
PV	[latex]-500,000[/latex]
FV	[latex]0[/latex]
PMT	[latex]3,000[/latex]
I/Y	[latex]5.2[/latex]
P/Y	[latex]12[/latex]
C/Y	[latex]12[/latex]

[latex]N=293.6601...[/latex]

Rounding up, Samia receives 294 monthly payments.

Step 2:  Convert (rounded UP) N to years and months.

[latex]\begin{eqnarray*} \mbox{Number of Years} & = & \frac{\mbox{rounded up }N}{P/Y} \\ & = & \frac{294}{12} \\ & = & 24.5 \\ & \rightarrow & 24 \mbox{ years} \\ \\ \mbox{Number of Months} & = & 0.5 \times 12 \\ & = & 6  \end{eqnarray*}[/latex]

Samia can receive payments for 24 years and 6 months.  If Samia is currently 60 years old and the annuity endures for 24 years and 6 months, then she will be 84.5 years old when the annuity is depleted. 

EXAMPLE

Brendan is purchasing a brand new Mazda MX-5 GT. Including all options, accessories, and fees, the total amount he needs to finance is $47,604.41 at the dealer’s special interest financing of 2.4% compounded monthly. If he makes payments of $1,000 at the end of every month, how long will it take to pay off his car loan?

Solution:

The timeline for the car payments appears below.

 

Step 1:  Calculate the value of N.

PMT Setting	END
N	?
PV	[latex]47,604.41[/latex]
FV	[latex]0[/latex]
PMT	[latex]-1,000[/latex]
I/Y	[latex]2.4[/latex]
P/Y	[latex]12[/latex]
C/Y	[latex]12[/latex]

[latex]N=50.0755...[/latex]

Rounding up, Brendan makes 51 monthly payments.

Step 2:  Convert (rounded UP) N to years and months.

[latex]\begin{eqnarray*} \mbox{Number of Years} & = & \frac{\mbox{rounded up }N}{P/Y} \\ & = & \frac{51}{12} \\ & = & 4.25 \\ & \rightarrow & 4 \mbox{ years} \\ \\ \mbox{Number of Months} & = & 0.25 \times 12 \\ & = & 3  \end{eqnarray*}[/latex]

To own his vehicle, Brendan will make payments for 4 years and 3 months.

EXAMPLE

Trevor wants to save up $1,000,000. He will contribute $2,500 every six months to an investment earning 5.2% compounded quarterly. How long will it take for Trevor to reach his goal?

Solution:

Step 1:  Calculate the value of N.

PMT Setting	END
N	?
PV	[latex]0[/latex]
FV	[latex]1,000,000[/latex]
PMT	[latex]-2,500[/latex]
I/Y	[latex]5.2[/latex]
P/Y	[latex]2[/latex]
C/Y	[latex]4[/latex]

[latex]N=94.436...[/latex]

Rounding up, Trevor will need to make 95 payments.

Step 2:  Convert (rounded UP) N to years and months.

[latex]\begin{eqnarray*} \mbox{Number of Years} & = & \frac{\mbox{rounded up }N}{P/Y} \\ & = & \frac{95}{2} \\ & = & 47.5 \\ & \rightarrow & 47 \mbox{ years} \\ \\ \mbox{Number of Months} & = & 0.5 \times 12 \\ & = & 6 \end{eqnarray*}[/latex]

Trevor will need to make the semi-annual payments for 47 years and 6 months to reach his goal.

TRY IT

Amarjit wants to save up for a down payment on his first home. A typical starter home in his area sells for $250,000 and the bank requires a 10% down payment. If he starts making $300 month-end contributions to an investment earning 4.75% compounded monthly, how long will it take for Amarjit to have the necessary down payment?

 

Click to see Solution

PMT Setting	END
N	?
PV	[latex]0[/latex]
FV	[latex]25,000[/latex]
PMT	[latex]-300[/latex]
I/Y	[latex]4.75[/latex]
P/Y	[latex]12[/latex]
C/Y	[latex]12[/latex]

[latex]N=72.1612...\rightarrow 73 \mbox{ payments}[/latex]

[latex]\begin{eqnarray*} \mbox{Number of Years} & = & \frac{\mbox{rounded up }N}{P/Y} \\ & = & \frac{73}{12} \\ & = & 6.0833... \\ & \rightarrow & 6 \mbox{ years} \\ \\ \mbox{Number of Months} & = & 0.833... \times 12 \\ & = & 1 \end{eqnarray*}[/latex]

It will take 6 years and 1 month.

TRY IT

Hi-Tec Electronics is selling a 52″ LG HDTV during a special “no sales tax” event for $1,995 with end of month payments of $100 including interest at 15% compounded semi-annually. How long will it take a consumer to pay off her new television?

 

Click to see Solution

PMT Setting	END
N	?
PV	[latex]1,995[/latex]
FV	[latex]0[/latex]
PMT	[latex]-100[/latex]
I/Y	[latex]15[/latex]
P/Y	[latex]12[/latex]
C/Y	[latex]2[/latex]

[latex]N=22.9783...\rightarrow 23 \mbox{ payments}[/latex]

[latex]\begin{eqnarray*} \mbox{Number of Years} & = & \frac{\mbox{rounded up }N}{P/Y} \\ & = & \frac{23}{12} \\ & = & 1.9166... \\ & \rightarrow & 1 \mbox{ years} \\ \\ \mbox{Number of Months} & = & 0.9166... \times 12 \\ & = & 11 \end{eqnarray*}[/latex]

It will take 1 year and 11 months.

Exercises

1. You make $3,000 quarterly payments into a savings account earning 6.35% compounded quarterly. How long will it take you to accumulate $100,000?
   
   Click to see Answer

   6 years, 9 months

    

2. You make $2,500 contributions at the beginning of every six months into your RRSP. If the RRSP earns interest at 7% effective, how long will it take your RRSP to reach an accumulated value of $175,000?
   
   Click to see Answer

   18 years

    

3. You took a $50,000 loan at 7.2% compounded quarterly. The loan agreement requires you to make monthly payments of $500 until the loan is paid off. How long will it take you to repay the loan?
   
   Click to see Answer

   12 years, 9 months

    

4. Your have $1,000,000 in your RIF. You want to receive $40,000 beginning-of-quarter payments for as along as possible from the RIF. If the RIF earns 9% compounded monthly, how long will it take to exhaust the RIF?
   
   Click to see Answer

   9 years, 3 months

    

5. An investment of $100,000 today will make advance quarterly payments of $4,000. If the annuity can earn 7.3% compounded semi-annually, how long will it take for the annuity to be depleted?
   
   Click to see Answer

   8 years, 3 months

    

6. The neighbourhood grocery store owned by Raoul needs $22,500 to upgrade its fixtures and coolers. If Raoul contributes $3,000 at the start of every quarter into a fund earning 5.4% compounded quarterly, how long will it take him to save up the needed funds for his store’s upgrades?
   
   Click to see Answer

   2 years

    

7. Andre has stopped smoking. If he takes the $80 he saves each month and invests it into a fund earning 6% compounded monthly, how long will it take for him to save $10,000?
   
   Click to see Answer

   8 years, 2 months

    

8. How much longer will a $500,000 investment fund earning 4.9% compounded annually last if beginning-of-month payments are $3,500 instead of $4,000?
   
   Click to see Answer

   3 years, 2 months

    

9. Consider a $150,000 loan with month-end payments of $1,000. How much longer does it take to pay off the loan if the interest rate is 6% compounded monthly instead of 5% compounded monthly?
   
   Click to see Answer

   3 years, 6 months

    

10. You make $250 month-end contributions to your RRSP, which earns 9% compounded annually.
    1. How much less time will it take to reach $100,000 if you increase your payments by 10%?
    2. Which alternative requires less principal and by how much? (Assume all payments are equal.)
    Click to see Answer

    a. 9 months; b. regular payments require $2250 less principal

     

11. Most financial institutions tout the benefits of “topping up” your mortgage payments—that is, increasing from the required amount to any higher amount. Assume a 25-year mortgage for $200,000 at a fixed rate of 5% compounded semi-annually.
    1. How many fewer payments does it take to pay off your mortgage if you increased your monthly payments by 10%?
    2. How much money is saved by “topping up” the payments? Assume that all payments are equal amounts in your calculations.
    Click to see Answer

    a. 48 fewer payments; b. $26,521.44

Attribution

“11.5: Number of Annuity Payments” from Business Math: A Step-by-Step Handbook Abridged by Sanja Krajisnik; Carol Leppinen; and Jelena Loncar-Vines is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.

“11.5: Number of Annuity Payments” from Business Math: A Step-by-Step Handbook (2021B) by J. Olivier and Lyryx Learning Inc. through a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License unless otherwise noted.