An annuity is a number of payments that may be paid or received by an individual. Annuities are equal amounts that are paid or received over a set period. Examples of annuities include mortgage payments, rent payments, insurance premiums, salaries, retirement benefits, etc. There are different types of annuities with different features. The article takes a closer look at two such annuities; the more commonly found ordinary annuity and annuity due.
What is Ordinary Annuity?
An ordinary annuity refers to a series of payments that is made over a fixed period at the end of each period, which may be at the end of every month, week, year, quarterly, or semi-annually depending on the length of the period. Ordinary annuities are also known as annuities in arrears as they are paid at the end of the period instead of being made in the beginning. Examples of an ordinary annuity include a mortgage payment (at a fixed rate), bond with fixed rate coupon payments, salary of a worker who owns a fixed sum, etc. There are two annuity formulas that are used to calculate the present value of an ordinary annuity and the future value of an ordinary annuity.
The annuity formula to calculate the present value of an ordinary annuity is:
The annuity formula to calculate the future value of an ordinary annuity is:
Where, C = is the cash flow for the period, i = interest rate and n = number of years
What is Annuity Due?
An annuity due is quite the opposite to an ordinary annuity. An annuity due is a series of payments that is made at the beginning of the payment period for a fixed period. Examples of an annuity due include rent payments , insurance premiums, etc. Below are the two annuity formulas that are used to calculate the present value of an annuity due and the future value of an annuity due.
The annuity formula to calculate the present value of an annuity due is:
The annuity formula to calculate the future value of an annuity due is:
Where, C = is the cash flow for the period, i = interest rate and n = number of years
What is the difference between Ordinary Annuity and Annuity Due?
Annuities are a series of fixed payments made over a fixed period over regular intervals. Ordinary annuities and annuity due are two such types of annuities. There are, however, a number of differences between ordinary annuity and annuity due. While an ordinary annuity is paid at the end of the period, an annuity due is paid at the beginning of the period. If you are the party who is making the payment then an ordinary annuity is beneficial. On the other hand, if you are the party receiving the payment then an annuity due is beneficial. This is because of the principle of the time value of money. Due to rising levels of inflation, a dollar today is worth more than a dollar tomorrow. When making a payment, the more it can be delayed the less it will cost. In terms of receipts, the earlier you can obtain the funds the more it will be worth.
Summary:
Ordinary Annuity vs Annuity Due
• An annuity is a number of payments that may be paid or received by an individual. Annuities are equal amounts that is paid or received over a set period.
• An ordinary annuity refers to a series of payments that is made over a fixed period at the end of each period, which may be at the end of every month, week, year, quarterly, or semiannually depending on the length of the period.
• An annuity due is quite the opposite of an ordinary annuity. An annuity due is a series of payments that is made at the beginning of the payment period for a fixed period.
• If you are the party who is making the payment then, an ordinary annuity will be beneficial. On the other hand, if you are the party receiving the payment then an annuity due will be beneficial. This is because of the principle of the time value of money.
Further Reading:
1. Difference Between Annuity and Perpetuity
2. Difference Between Pension and Annuity
3. Difference Between Fixed and Variable Annuities