An individual retirement account (IRA) is a type of annuity that workers use to save money for retirement. The earner contributes money each year to the account, which grows with interest until the owner retires. The government does not collect tax on IRA contributions, substantially increasing the account's rate of compound growth. When the account holder dies before reaching retirement, the balance of the IRA or other annuities goes to a beneficiary of the decedent. This balance's present value describes it in terms of today's dollars, taking predicted inflation into account.
1. Add one to the IRA or other annuity's growth rate. For example, if the annuity will grow by 6 percent a year, add 1 to 0.06, giving 1.06.
2. Raise this sum to the power of the number of years until the account holder dies. For instance, to calculate the present value of an IRA if the holder will die in 25 years, raise 1.06 to the power of 25, giving 4.292.
3. Subtract 1 from the result. Continuing the example, 4.292 minus 1 gives 3.292.
4. Divide this answer by the account's growth rate. 3.292 divided by 0.06 gives 54.87. This is the interest factor, the factor relating the annual contribution to the annuity with the annuity's final value.
5. Multiply the annual contribution to the annuity by the interest factor. If the decedent spends his lifetime donating $2,000 to the annuity each year, the maximum annually IRA contribution as of 2011, multiply $2,000 by 54.87, giving $109,740. This is the annuity's future value.,
6. Add one to the inflation rate. Assuming an inflation rate of 3 percent, add 1 to 0.03, giving 1.03.
7. Raise this sum to the number of years until the decedent dies. Continuing the example raise 1.03 to the power of 25, giving 2.094.
8. Divide the annuity's future value by this discount multiplier. $109,740 divided by 2.094 gives $52,406.87. This is the present value of the decedent's IRA or annuity.
- IRS.gov: Publication 590 (2010), Individual Retirement Arrangements (IRAs)
- Quantitative Methods for Finance and Investments; John L. Teall and Iftekhar Hasan
- Financial Mathematics; Budi Frensidy
- Hemera Technologies/AbleStock.com/Getty Images