Are you considering investing in an annuity but wondering which type best suits your needs? An annuity is a financial product that provides you with a stream of income in exchange for a lump sum of money.
There are two types of annuities – ordinary annuity and annuity due. While they may seem similar, they differ significantly in their structure and payment timing. In this blog post, we’ll explore the differences between ordinary annuities and annuity dues and help you make an informed decision about the one that’s right for you.
An ordinary annuity is an investment product where the payments are made at the end of each period. For instance, if you start an ordinary annuity with monthly payments of $200 for ten years, you’ll receive $200 at the end of each month.
On the other hand, an annuity due is an investment product where the payment is made at the beginning of each period. In the same scenario, if you start an annuity due with monthly payments of $200 for ten years, you’ll receive $200 at the start of each month.
Timing of Payments
The primary difference between the two annuity types is the timing of payments. With an ordinary annuity, payments are made at the end of each period, so the first payment comes at the end of the first period, whether it’s a month, a quarter, or a year. In contrast, with an annuity due, payments are made at the beginning of each period, so the first payment comes at the start of the first period.
The present value of an annuity is the current value of all future payments, considering a specified interest rate. Because payments in an ordinary annuity are made at the end of the period, the present value of the payments is lower than that of an annuity due. This is because the longer the time before you receive your payments, the greater the time value of money lost. Thus, in an ordinary annuity, you need to contribute more money to get the same future value as an annuity due.
Another critical factor to consider is life expectancy. With an annuity due, if you pass away, your beneficiaries will receive the remaining payments. On the other hand, with an ordinary annuity, your beneficiaries receive nothing after your passing. Therefore, if you want to ensure that your beneficiaries receive any outstanding payments, you should opt for an annuity due.
Lastly, annuity dues have a contributory structure that requires you to contribute more in the early years than in the later years. Conversely, an ordinary annuity has a uniform payment structure in which you contribute the same amount every year. The front-loading of contributions in annuity dues allows investors to enjoy more extended tax-deferred contributions.
In conclusion, there are significant differences between an ordinary annuity and an annuity due. While they may seem similar in many ways, their payment timing, present values, life expectancies, and contributory structures vary significantly. When deciding between the two, it’s essential to consider your personal financial goals, life expectancy, contribution capacity, and tax implications. Speak with a financial advisor to help you make an informed decision, choose the right annuity for you, and enjoy a secure financial future.