Present Value Interest Factor of Annuity (PVIFA) Formula, Tables

What Is the Present Value Interest Factor of Annuity (PVIFA)?

The present value interest factor of an annuity (PVIFA) is a calculation that can help an investor entering into an annuity contract to determine whether it is more advantageous to take a lump-sum payment or to accept a series of payments over time.

The present value interest factor of an annuity is used to calculate the present value of a series of annuities when it is multiplied by the recurring payment amount. The initial deposit earns interest at the interest rate (r), which perfectly finances a series of (n) consecutive withdrawals and may be written as the following formula:

• PVIFA = (1 - (1 + r)^-n) / r

PVIFA is also a variable used when calculating the present value of an ordinary annuity.

Understanding the Present Value Interest Factor

The present value interest factor is based on the concept of the time value of money, which states that a sum of money today has greater value than the same sum of money at a future date due to its earnings potential.

The present value interest factor can be used to determine whether to take a lump-sum payment now or accept an annuity payment in future periods. Using estimated rates of return, you can compare the value of the annuity payments to the lump sum.

The present value interest factor may only be calculated if the annuity payments are for a predetermined amount spanning a predetermined range of time.

Tools to Calculate PVIFA

Online tools are available to estimate PVIFA. You can use either of the following:

• A PVIFA calculator, which determines PVIFA for any combination of entries for an interest rate (r), and a number of payments (n)
• A PVIFA table, which displays the most common interest rates and number of payments.

The major drawback of a present value interest factor table is the necessity to round calculated figures, which sacrifices precision.

Using the Discount Rate for the Present Value Interest Factor

The discount rate used in the present value interest factor calculation approximates the expected rate of return for future periods. It is adjusted for risk based on the duration of the annuity payments and the investment vehicle utilized. Higher interest rates result in lower net present value calculations. This is because the value of $1 today is diminished if high returns are anticipated in the future.

Present Value Interest Factor of Annuity Due

If annuity payments are due at the beginning of the period, the payments are referred to as an annuity due. To calculate the present value interest factor of an annuity due, take the calculation of the present value interest factor and multiply it by (1+r), with "r" being the discount rate.

The Bottom Line

Calculating the present value interest factor of an annuity provides a useful way to determine if a lump-sum payment now is a better option than future annuity payments.

The formula, based on the potential interest rate and the number of payment periods, will give you a point of comparison between options.