What Is an Annuity Due?

What Is an Annuity Due?

Let me explain what an annuity due is directly to you. It's an annuity where the payment is due right at the start of each period. Think about rent as a prime example—landlords usually demand payment at the beginning of the month, not after you've lived there for the whole time.

Key Takeaways

You need to know that annuity due payments happen at the beginning of the period, while ordinary annuity payments come at the end. Rent fits the annuity due model perfectly. On the other hand, a mortgage is a standard ordinary annuity. Remember, the formulas for present and future values differ slightly between the two because of when the payments occur.

How an Annuity Due Works

An annuity due means you make or receive payments at the start of each period, not the end. If you're receiving these payments, they count as an asset legally. If you're paying, it's a debt you have to settle periodically.

These payments form a series of future cash flows, so you might want to figure out the total value considering the time value of money. You do this with present value calculations.

You'll find a present value table for annuity due with interest rates on top and periods on the side. The cell where they meet gives you the multiplier. Multiply that by one payment to get the present value of the flow.

A whole life annuity due, sold by insurance companies, pays at the start of each period—monthly, quarterly, or annually—and continues for your lifetime. Any leftover funds stay with the company after you pass. Keep in mind, income from annuities gets taxed as ordinary income.

Annuity Due vs. Ordinary Annuity

An annuity due involves recurring payments at the beginning of the period, while an ordinary annuity has them at the end. Contracts specify this based on when benefits are received. You pay annuity due before getting the benefit, like for an expense, but ordinary annuity after the benefit.

Timing matters a lot due to opportunity costs. If you're collecting, an annuity due lets you invest the money right away for interest or gains, making it better for you. But if you're paying, you lose the chance to use that money during the period, so you'd prefer an ordinary annuity.

Examples of an Annuity Due

Annuity due comes up in many recurring obligations. Monthly bills like rent, car payments, or cellphone bills often require payment at the start of the period. Insurance premiums are typically annuity due, paid upfront for coverage.

You also see this in saving for retirement or setting aside money for a goal.

How to Calculate the Value of an Annuity Due

You calculate present and future values of an annuity due with tweaks to the ordinary annuity formulas, accounting for the early payments.

Present Value of an Annuity Due

The present value shows you the current worth of expected future payments—what they're worth now. It's similar to ordinary annuity calculations but adjusted since payments start at the beginning.

The formula is: PV(Annuity Due) = C × [ (1 - (1 + i)^(-n)) / i ] × (1 + i), where C is cash flow per period, i is interest rate, n is number of payments.

Take this example: You're getting $1,000 yearly for 10 years at 3% interest. The present value comes to $8,786.11.

Future Value of an Annuity Due

The future value tells you the end value of these payments at a future point. It differs from ordinary annuity due to timing.

The formula is: FV(Annuity Due) = C × [ ((1 + i)^n - 1) / i ] × (1 + i). Using the same example, it's $11,807.80.

Which Is Better, an Ordinary Annuity or an Annuity Due?

It depends on your role. If you're receiving, annuity due is better because you get funds upfront, boosting present value. If you're paying, ordinary annuity lets you hold onto money longer.

You usually can't choose; it's set by the contract. Insurance premiums are annuity due, car payments ordinary.

What Is an Immediate Annuity?

An immediate annuity starts payments right after a lump-sum deposit, for a fixed amount, period, or lifetime.

What Happens When an Annuity Expires?

When it expires, payments stop, and obligations end.

What Does Annuity Mean?

An annuity is an insurance product for generating payments now or later. You fund it with lump sums or series, getting immediate or deferred income with tax-deferred growth.

The Bottom Line

To wrap this up, an annuity due pays at the start of the interval, ordinary at the end. Calculations differ accordingly. Rent is annuity due, mortgages ordinary. Your preference depends on if you're paying or receiving.