What Is the Difference Between an Ordinary Annuity & an Annuity Due?

There is a difference between an ordinary annuity and one due.

An annuity is defined as a stream of payments over a fixed period of time. Most people normally think of retirement when they think of an annuity. However, a mortgage payment, car payment, college savings plan or other regular-interval occurring payment are also classified as annuity.

Function

An annuity is associated with an interest rate, the time value of money and a fixed period of time. Examples would be an annuity set up to accumulate $250,000 over a 20-year period or an annuity set up to pay off a mortgage of $150,000 over 15 years.

Types

The two main types of annuities are the ordinary annuity and the annuity due. An ordinary annuity is one in which payments are made at the end of the period. A popular ordinary annuity would be a fixed rate mortgage. At the end of each month, a person makes a payment; the time period is set at a certain number of years. An annuity due is the same type of instrument as an ordinary annuity with one exception--payments are made at the beginning of each period. The obvious advantage to putting money in an account in the beginning is that it starts earning interest immediately.

Features

Consider a mortgage (an ordinary annuity). If a person paid the whole mortgage off after two monthly payments, he would pay a lot less than if he made all the payments as scheduled over 15 or 30 years? Of course he would pay less interest because interest accrues over time, and he has allowed less time to pass--or shortened the time period. It is possible to also set up a retirement fund as an ordinary annuity and not put in any money until the end of the first period; a benefit would be to lock in the interest rate.

Considerations

When choosing which product will best suit your needs, you must first determine what you want from your payments. For example, if you want to save $1 million, you would need to determine how much you can put into an account each month which earns some percentage interest (compounded monthly), then you can determine how many monthly payments you would need to make by calculating the present value of those $2,000 monthly payments--an easy feat with a calculator.

Benefits

The benefits of an annuity are the guaranteed stream of payments. Back to the previous example, after you have saved your $1 million, say at age 61, you decide you want to get 15 annual installments back out. You will have that steady stream of income that you have saved over the years. You did not have to put the whole amount in, because everything you put in immediately starts earning interest.

References

• Annuities Explained