Ordinary Annuity vs Annuity Due
What Is an Annuity?
An annuity is a series of cash flows occurring over time.
There are different types of annuities, but they all share the same concept: systematic future inflow followed by systematic future outflow.
The two most common forms of annuities are ordinary annuity and annuity due.
What Is an Ordinary Annuity?
An ordinary (or straight line) annuity has equal payments that occur at regular intervals, with the first payment made immediately.
An example would be $100 per month for 3 years beginning at age 21, where each payment is made at the end of the month. The first payment starts 1 month after turning 21 years old. Each subsequent monthly payment continues to occur 1 month after the end of each previous month.
What Is an Annuity Due?
An annuity due has unequal payments occurring at regular intervals, with the first payment occurring immediately.
A common example would be $100 per month for 3 years beginning today, where each payment is made at the beginning of the month. The first payment starts one month from today. Each subsequent monthly payment continues to occur 1 month after the beginning of each prior month.
Key Differences Between Ordinary Annuity and Annuity Due
Here are some key differences to take note in order to distinguish an ordinary annuity from an annuity due:
The main difference between an ordinary annuity and an annuity due is in the payment schedule.
With an ordinary annuity, payments are evenly spaced out over time, with the first payment due at the end of the period.
With an annuity due, payments are unevenly spaced out over time, with the first payment made immediately at the start of the period.
In addition to the different payment schedules for an ordinary annuity and an annuity due, there is also a difference between calculating their present value.
Because of inflation, the value of a dollar today is higher compared to a dollar at a later date.
This makes the value of payments made via ordinary annuity less than the value of payments made via annuity due.
This is because in order to receive the same purchasing power at a later date, you would need more payments with an annuity due than with an ordinary annuity.
Best Used For
Ordinary annuities are best used for payments because they have a lower present value than an annuity due.
This is because payments made through ordinary annuity are more exposed to inflation.
An annuity due is best used for receipts because they have a higher present value than an ordinary annuity.
Ordinary annuity is ideal for mortgage payments, while annuity due is ideal for insurance premiums.
Present Value Calculation
Present Value of an Ordinary Annuity
Present Value of an Annuity Due
All else equal, the present value of payments made through ordinary annuity will always be lesser than that of an annuity due.
The Bottom Line
Annuities are a series of cash flows occurring over time. Annuities have two types: ordinary annuity and annuity due.
With an ordinary annuity, the first payment is made after a period of time.
With an annuity due, the first payment is made at the beginning of a period.
An ordinary annuity has a lower value compared to an annuity due because payments through ordinary annuities are more exposed to inflation.
Thus, in general, it is best used for making cash flows/payments while an annuity due is best used for receiving cash flows/payments when looking at them from a present value perspective.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.