What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Annuity Due Vs. Ordinary Annuity

Original post by Ashley Mott of Demand Media

Annuities pay out and are paid into on a fixed cycle.

The term "annuity" refers to a series of fixed payments that are either received or paid out by an individual. Annuity payments are fixed both in terms of the dollar amount of funds paid and the length of time the funds are paid. Both the ordinary annuity and annuity due are common annuity types.

Annuity Due

When an annuity due is paid, the payment covers a payment period occurring after the payment. This leaves the annuity due to be commonly described as a payment occurring at the beginning of a pay period. Any fixed payment for a service or property that occurs before a service period begins is an example of an annuity payment. Common applications include rent payments, telephone service through certain companies and insurance premiums.

Ordinary Annuity

The payment on an ordinary annuity occurs after the payment period has elapsed or at the end of the pay period. Most installment loans can be classified as ordinary annuities, as can the coupon payments associated with straight bonds. Mortgages with the first payment due a month after the initial loan date are one of the most common example of an ordinary annuity.

Overlap

Despite the separate applications of the annuity due and ordinary annuity, calculating both the present and future value of an annuity due requires the ordinary annuity as part of the formula. Because of this, the present and future value of an annuity due remains slightly greater than the value of an ordinary annuity subject to the same payments, interest and financing time period until the last payment occurs.

Application

An ordinary annuity and annuity due subject to the same payments, interest and payment period would yield the same total payment at the end of the final payment period, since the ordinary annuity would have a final end-of-month payment after the annuity due's last beginning-of-the-month payment. Since cash-in-hand is considered a better option in financial terms, the annuity due becomes a more attractive option than the ordinary annuity with its delayed first payment.

Retirement Planning

For individuals planning to use annuities to supplement Social Security benefits or other pensions later in life, the ordinary annuity and annuity due offer different advantages. The first-of-the-month payment of the annuity due provides faster access to cash when retirement occurs and would allow the retiree to immediately begin gaining interest on funds contributed prior to the disbursement period. However, the ordinary annuity is not restricted to an end-of-month start-up. If a competitive interest rate offered on an ordinary annuity could change in the immediate future, you may opt to set up the fund and then schedule your first contribution for the end of the first period. This allows you to grab the competitive interest while securing the end-of-month contribution preferred. If you put funds in multiple annuities, you may choose to opt for a mixture of ordinary annuities and annuities due in order to receive funds at the beginning and end of the month in addition to the regular payment of your Social Security annuity or pension.

                   

References

About the Author

Ashley Mott has been self-employed since graduating high school. She started an e-commerce business in 2005 that utilized pre-existing websites to market antique books, retail clothing and liquidated beauty products. In 2008 Mott began her "for-profit" writing career.

Photo Credits

  • PhotoObjects.net/PhotoObjects.net/Getty Images

Advertisement