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How is Annuity Due different from General Annuity?
Annuity Due is a payment of receipt of a fixed amount of money at the beginning of each period for a specified number of periods. It is different from general/ordinary annuity in which the payments are made after the end of each payment cycle. One may find an Annuity Due while paying rent, planning for retirement, borrowing money, or buying an annuity.
Since the concept of Annuity is based on Time Value of Money, the payer usually prefers to pay ordinary annuities. This helps them have the money for coming periods. The lender, however, prefers Annuity Due because they get to hold the money sooner which can be invested again thereafter.
Note − Annuity Due, like Ordinary Annuity, is based on the principle of Time Value of Money. The earlier payments are received, the better it is for the lender.
Examples of Annuity Due
One kind of Annuity Due can be found while leasing something. When someone leases an asset, the payments are usually collected at the beginning of the month or year. This payment is for the next period, not the preceding one. Leasing is usually done for a longer period but the collections for them are set at the beginning of each term.
Another example of Annuity Due is found while paying the premiums for insurance. Health and general insurance usually collect the money for the next period which maybe a month, a year, or any other terms set. In this case, the payments are made for the coming period and not the one that just passed by.
Note − Annuity Due is common in the financial world. For example, leasing companies and insurance firms use it exclusively.
Does this make sense to prefer Annuity Due rather than General Annuity by lenders? For example, if a person opts for an Annuity Due that will pay INR 500 at the start of the month for 20 years at an interest rate of 8%.The PV of the annuity is approximately INR 60,376.
At the same rate and terms, the general annuity will yield INR 59,777. So, the difference is INR 396. This is not a huge amount for individuals but for companies that deal with a large number of individuals, such as Insurance Companies who have to pay a large sum, it does matter a lot.
Note − Large companies and financial organizations prefer Annuity Due, as it can help them save lots of money. The payments due at the beginning being more meaningful and useful for them.
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