An annuity due is a type of annuity that requires payments to be made immediately at the beginning of each period. One of the most common examples of this is rent payments, which are typically due at the start of each month.
Key Takeaways
- An annuity due involves payments at the beginning of each period.
- Unlike ordinary annuities, payments are not delayed until the end of each period.
- Common examples include rent and insurance premiums.
- Differences in timing result in different present and future value calculations compared to ordinary annuities.
How Annuity Due Works
An annuity due demands that payments be made at the start of each annuity period. This creates an asset for the individual receiving the payments and a liability for the one who is making them. To understand the total value of an annuity due while accounting for the time value of money, use the present value calculation.
In a present value table for an annuity due, you can find the present value multiplier by intersecting the chosen interest rate and the number of periods. Multiply one annuity payment by this multiplier to find the present value of the cash flow.
Whole life annuity due products, often sold by insurance companies, require payments at the beginning of each period. These contribute towards the holder’s finances until death, benefiting the insurance company thereafter. Income from such annuities is typically taxed as ordinary income.
Annuity Due vs. Ordinary Annuity
Annuity due payments recur at the beginning of the period, whereas ordinary annuity payments occur at the end. The timing affects the opportunity cost for both payers and payees. Annuity due beneficiaries can invest the payments earlier to earn returns faster, making it more beneficial for the recipient. However, payers may lose out on the financial advantage of using those funds for the entire period, something that makes ordinary annuities more preferable for them.
Practical Examples of Annuity Due
Multiple recurring costs could qualify as annuities due. Examples include rent, car payments, and cellphone bills which are usually paid at the beginning of the billing period. Even insurance premiums are generally required upfront at the start of coverage. Moreover, annuity due scenarios are often seen in retirement savings plans.
How to Calculate the Value of an Annuity Due
Present and future values can both be calculated for annuities due with slight modifications.
Present Value of an Annuity Due
The present value of an annuity due indicates the current value of future annuity payments due to be received. Use the formula:
[ PV(Annuity Due) = C x \[((1 - (1 + i)^{-n})/i) x (1 + i)\] ]
Where:
- C = cash flows per period
- i = interest rate
- n = number of payments
Suppose a beneficiary is due to receive $1000 annually for ten years at an interest rate of 3%. The present value is approximately $8786.11.
Future Value of an Annuity Due
The future value of an annuity due expresses the value of periodic payments at a future point. The formula is:
[ FV(Annuity Due) = C x \[((1 + i)^{n} - 1)/i) x (1 + i)\] ]
For the same example, the future value, given a 3% interest rate, would be approximately $11807.80.
Frequently Asked Questions (FAQs)
Which Is Better, Ordinary Annuity or Annuity Due?
The suitability depends on your position—whether you’re the payer or the payee. Payees generally favor annuity dues for the immediate access to funds, whereas payers might prefer ordinary annuities for extended use of funds within a period.
What Is an Immediate Annuity?
An immediate annuity refers to an account that provides an instant income stream derived from a lump sum deposit. Payments can be fixed or based on a specified term or lifetime.
How Do You Calculate the Future Value of an Annuity Due?
You use the formula:
[ FV(Annuity Due) = C x \[((1 + i)^{n} - 1)/i) x (1 + i)\] ]
What Does Annuity Mean?
An annuity is an insurance product designed to offer periodic payments from either a single upfront or multiple periodic contributions.
What Happens When an Annuity Expires?
When an annuity expires, contractual obligations terminate and the continuous payments cease.
The Bottom Line
Annuities due require upfront payments, offering various benefits and drawbacks depending on the role—payer or payee. With critical differences from ordinary annuities, understanding these nuances is vital for optimized financial planning.
Related Terms: present value, future value, ordinary annuity, immediate annuity, insurance premium
