Ordinary Annuity vs Annuity Due – What’s the Difference?

What Is Ordinary Annuity vs Annuity Due?

There are several key differences between an ordinary annuity vs annuity due. An annuity is a series of payments made or received over a predetermined period of time. The timing of those payments differs based on the type of annuity. In general, the most notable differences are how they payout and how they are valued.

Ordinary Annuity

An ordinary annuity is a payment against a larger obligation. For example, a phone bill is not, but a car payment or student loan payment is. Additionally, each payment in an ordinary annuity is the same.  Also, each payment period is fixed to the same interval.  An ordinary annuity makes its payment at the end of each payment period or interval period. For example, if an annuity has monthly intervals, it will make payments at the end of each month. Examples include mortgages paid at the end of the month, income annuities, and dividend payments, which are usually made at the end of each quarter.

Unlike buying stocks or bonds or funds, buying an annuity means buying an insurance policy – not buying securities. Specifically, an annuity is a contract to guarantee a series of structured payments over time. It starts at a predetermined date and lasts for a predetermined time.  For example, many retirement products are annuities that pay out fixed sums each month in retirement.

Annuity Due

Annuity due refers to a series of equal payments made at the same interval at the beginning of each period. Periods can be monthly, quarterly, semi-annually, annually, or any other defined period. Examples of annuity due payments include rentals, leases, and insurance payments.  The payments are made to cover services provided in the period following the payment.  Therefore, annuity due is an annuity whose payment is due immediately at the beginning of each period. A common example of an annuity due payment is rent.  Landlords often require payment upon the start of a new month as opposed to collecting it after use for an entire month.

Key Differences: Ordinary Annuity vs Annuity Due

There are several key differences between an ordinary annuity and an annuity due. Some of the most notable differences are how they payout and how they are valued. Here is a breakdown of the differences between an ordinary annuity vs annuity due:

Payouts

With an ordinary annuity, the payments are made at the end of the period.  With an annuity due, payments are made at the start of each period or interval. Ordinary annuity payments include loan repayments, mortgage payments, bond interest payments, and dividend payments.

The most notable difference between ordinary annuities and annuities due is the way they payout. All annuities make a payment once per period, just like how bills are due during each billing cycle. The payments come at the end of the period or the beginning. With ordinary annuities, the payments come at the end of each payment period. With annuities due, the payment comes at the beginning. In general, loan payments are made at the end of a cycle and are ordinary annuities. In contrast, insurance premiums are typically due at the beginning of a billing cycle and are annuities due.

(Source: smartasset.com)

Present Value

The present value of an annuity is the cash value of all future annuity payments.  It is based on the time value of money. The time value of money is the concept that a dollar today is worth more than a dollar at the end of the year due to inflation. When comparing annuities, it is essential to remember that the timing of a billing cycle can have a significant impact on the present value of the annuity. As a consumer, you can ask your lender or investment advisor to show you an annuity schedule.

An annuity due typically has a higher present value than an ordinary annuity.  This is because payments are made sooner with an annuity due than with an ordinary annuity. When interest rates go up, the value of an ordinary annuity goes down. On the other hand, when interest rates fall, the value of an ordinary annuity goes up. This is due to the concept known as the time value of money.  It states that money available today is worth more than the same amount in the future.  Invested today, it has the potential to generate a return and grow. Put another way, $100 today is worth more than $100 one year from now.

Annuity due payments are received earlier than an ordinary annuity. Therefore, if you are set to make ordinary annuity payments, you will benefit from getting an ordinary annuity by holding onto your money longer. Conversely, if you are set to receive annuity due payments, you will benefit, as you will be able to receive your money sooner. In any annuity due, each payment is discounted one less period in contrast to a similar ordinary annuity.

Why it Matters

If you make your payment at the end of a billing cycle, your payment will likely be larger than if your payment is due immediately due to interest accrual. Lenders and investment firms calculate annuities. As a consumer, you have access to the annuity calculations as they are used to calculate how much you are charged.

Ordinary Annuity vs Annuity Due – Which Is Best?

If you’re liable for making payments on an annuity, you’ll benefit from having an ordinary annuity.  This is because it allows you to hold onto your money for a longer amount of time. However, if you’re on the receiving end of annuity payments, you’ll benefit from having an annuity due, as you’ll receive your payment sooner.

In general, an ordinary annuity is most advantageous for a consumer when they are making payments. Conversely, an annuity due is most advantageous for a consumer when they are collecting payments. The payments made on an annuity due have a higher present value than an ordinary annuity due to inflation and the time value of money.  An ordinary annuity is when a payment is made at the end of a period. An annuity due is when a payment is due at the beginning of a period. While the difference may seem meager, it can make a significant impact on your overall savings or debt payments. Keep in mind that an annuity – which is not an investment but rather an insurance product – may not be suitable for everyone. As you plan for retirement, it’s important to learn the pros and cons of annuities.

(Source: ibid)