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Annuity due is defined as a series of recurring equal payments which are due to be paid at the beginning of regular intervals such as monthly, quarterly, or annual payment cycles. Some of the common examples of Annuity due are EMIs, rent, insurance premiums, etc. Annuity due differs from an ordinary annuity, as in the case of an ordinary annuity the payments are made at the end of each cycle instead of at the beginning. An insurance plan that pays annuity due would make the interest payment at the beginning of a period to the policyholder or beneficiary. If you want to calculate the future value of the annuity due, you can use the annuity due formula.
Future Value = P x {(1 + r) n – 1) / r} x (1 + r)
Where:
P = Value of each annuity payment
r = rate of interest
n = number of payment instances
Let us understand the calculations better with an example. Mr. P is planning to deposit an amount of INR 10,000 annually for a period of 10 years. The market rate of interest is going at 5% annually. In such a scenario
P = 10,000
r = 5%
n = 10
Future Value = 10000 x {(1 + 5%) 10 – 1) / 5%} x (1 + 5%)
= 10000 x {(1 + .05) 10 – 1) / .05} x (1 + .05)
= 10000 x {(1.05)10 -1) / .05} x (1.05)
= 1,32,067.87
As demonstrated by the example, the future value of the annuity due would be higher than the one accumulated through an ordinary annuity. This happens due to the extra compound interest for paying the annuity due at the beginning of the payment term.
In the first method, you will be able to multiply (1 + r) n by the present value of the annuity due. The current value of the annuity due formula is (1 + r) * P {1 – (1 + r) – n} / r.
An alternative method is making a comparison between the movements of cash in an ordinary annuity and that of the annuity due.
When (1 + r) is factored in, the annuity due cash flow becomes equal to the ordinary cash flow.
To conclude
The formula that we have used here is easy to understand and can be used in various stages of life.
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Annuity is the payment made at the end of a period and repeated at a particular frequency, such as monthly, quarterly, half-yearly, or annually.
Annuity due is an annuity payment that is made at the beginning of a particular period such as rent paid at the beginning of the month or quarter for the upcoming month or quarter.
It is calculated on the basis of a PV of an annuity due, the number of periods, and the effective interest rate.
It is the present value of future payments from the annuity, given a discount rate. If the discount rate is higher, the current value of the annuity is lower.
PayBima Team
PayBima is an Indian insurance aggregator on a mission to make insurance simple for people. PayBima is the Digital arm of the already established and trusted Mahindra Insurance Brokers Ltd., a reputed name in the insurance broking industry with 17 years of experience. PayBima promises you the easy-to-access online platform to buy insurance policies, and also extend their unrelented assistance with all your policy related queries and services.
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