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What is the Annuity Factor Method?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 08 November 2016
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    Conjecture Corporation
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From time to time, there is a need to make an early withdrawal from the balance of a retirement account. Depending on the amount of the withdrawal, there is the chance of incurring penalties. However, there are methods of calculation that can be employed to determine how much can be withdrawn and avoid any type of penalty. One of these modes of calculation is the annuity factor method. Here is some background on how the annuity factor method works, and why it is a good idea to use this method before making any type of early withdrawals from retirement accounts.

The process involved in the annuity factor method is actually very straightforward. Similar to the amortization method, the annuity factor method still relies on data that has to do with age, although the approach is slightly different. With annuity factor method, the balance contained within the account is divided by the present value of an annuity. The exact figure for the annuity is determined by the age of the individual at the time he or she entered into the retirement plan, plus one more unit for each succeeding year that the individual has been enrolled in the plan. Any figure below the amount determined after the calculation may be withdrawn on the basis of once per calendar year, without incurring any penalties.

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Choosing to make a withdrawal from your retirement plan based on the annuity factor method does have several advantages. First, the lack of penalties means fewer resources are wasted. Second, the amount may be sufficient to make it unnecessary to take out some sort of a loan to deal with a temporary financial setback. Finally, there is always the opportunity to replace the funds once the financial crisis has passed.

At the same time, regularly withdrawing funds from a retirement program when the need is not of a dire nature will only serve to cripple any efforts to prepare for the future. Even though the annuity factor method does identify an amount that can be withdrawn without penalties, the annuitant should look long and hard at the reasons behind the withdrawal before actually removing any amount from the retirement fund. The entire concept of annuity payments into a retirement program is to ensure the financial future. If at all possible, the funds should be left to accumulate from year to year. For this reason, great care should be taken, so that the annuity factor method does not become a tool in a standard practice of seeing how much money can be harvested in advance, and used for purposes that are really not in the best interests of the individual.

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