The term "annuity" refers to a series of fixed payments that are either received or paid out by an individual. Annuity payments are typically fixed both in terms of the dollar amount of funds paid and the length of time the funds are paid, although there may be exceptions to this pattern in certain annuity contracts. Both the ordinary annuity and annuity due are common annuity types.
When an annuity due is paid, the payment covers a payment period that occurs after the payment is made. 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 due payment. Common applications include rent payments, telephone service through certain companies and insurance premiums.
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.
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.
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.
For individuals who plan 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 benefits or pension payments.
- David R. Frick & Co., CPA: Time Value of Money Concepts
- YouTube: Choice Between Receiving Ordinary Annuity or Annuity Due
- Annuity. "Withdrawing Money from an Annuity." Accessed July 7, 2020.
- CNN Money. "Ultimate guide to retirement." Accessed July 7, 2020.
- Annuity. "Free Look Period." Accessed July 7, 2020.
Ashley Mott has 12 years of small business management experience and a BSBA in accounting from Columbia. She is a full-time government and public safety reporter for Gannett.