Table of Contents

What Are Ordinary Annuities, and How Do They Work?

By

澳洲幸运5开奖号码历史查询:Julia Kagan

Updated June 16, 2024

Fact checked by Kirsten Rohrs Schmitt

Part of the Series

Annuity Definition and Guide

Guide to Annuities: What They Are, Types, ওand How They Work

Annuities Overview

Types of Annuities: Part 1

Types of Annuities: Part 2

Calculating Present and Future Value

Tax Implications

Payouts, Distributions, and Withdrawals

Benefits and Risks

Ordinary Annuity: A series of equal payments made at the end of each period over a fixed amount of time. — Investopedia / Zoe Hansen

Definition

An ordinary annuity is a financial product that involves a series of equal payments made at the end of consecutive periods over a specified duration.

What Is an Ordinary Annuity?

An ordinary annuity is a series of equal payments made at the end of consecutive periods over a fixed length of time. Ordinary annuities may be paid monthly, quarterly, semi-annually, or annu꧑ally.

The o🍃pposite of an ordinary annuity is an annuity due, in which payments are made at the beginning of each period. A .rent payment is an annuity due. A mortgage payment is an ordinary annuity.

Neither an ordinary annuity nor an annuity du💟e refers to the financial product known as an annuity, though the👍y are related.

Key Takeaways

An ordinary annuity is a series of regular payments made at the end of each period, such as a month or a quarter.
In an annuity due, payments are made at the beginning of each period.
Stock dividends and bond dividends are examples of ordinary annuities. A monthly rent payment is an example of an annuity due.

How an Ordinary Annuity Works

An example of an ordinary annuity is the interest payment on a bond. These are generally made semiannually. Regular quarterly dividends from a stock that has maintained a 𒐪stable payout level for years are another example.

The 澳洲幸运5开奖号码历史查询:present value of🐠 an ordinary annuity is largely dependent on the prevailing interest rate.

Because of the 澳洲幸运5开奖号码历史查询:time value of money, rising interest rates reduce the present value of an ordinary annuity, while declining interest rates increase its present value. This is because the value of an annuity is b🍌ased on the return your money couldꦡ earn elsewhere. If you caജn get a higher interest rate&𒁏nbsp;somewhere else, the value of the annuity goes down.

Present Value of an Ordinary Annuity Example

The present value 🐬formula for an ordinary annuity takes into account three variables.♛ They are:

PMT = the period cash payment
r = the interest rate per period
n = the total number of periods

Gi🍎ven these variables, the present value of a🍨n ordinary annuity is:

Present Value = PMT x ((1 - (1 + r) ^ -n ) / r)

For example, if an ordinary annu♒ity pays $50,000 ꦛper year for five years and the interest rate is 7%, the present value would be:

Present Value = $50,000 x ((1 - (1 + 0.07) ^ -5) / 0.07) = $205,010

Important

An ordinary annuity will have a lower present value than an annuity due, all else be♒ing equal.

Present Value of an Annuity Due Example

An in🙈vestor with an ordinary annuity receives the payment at the end of the agreed time period.

An alternative is an annuity due, in which the investor receives the ꦜpayment at the beginning of the period. A common example is rent. The renter typically pays🐷 the landlord in advance for the month ahead.

This difference💙 in payment timing affects the value ღof the annuity. The formula for an annuity due is as follows:

Present Value of Annuity Due = PMT + PMT x ((1 - (1 + r) ^ -(n-1) / r)

If the annuity in the above 🐬example was instead an annuity due, 𒀰its present value would be calculated as:

Present Value of Annuity Due = $50,000 + $50,000 x ((1 - (1 + 0.07) ^ -(5-1) / 0.07) = $219,360.

All else being equal, an annuity due 澳洲幸运5开奖号码历史查询:is worth more than an ordin🎃ary annuity because the money is received earli✅er.

Is an Ordinary Annuity Better Than an Annuity Due?

Generally, an annuity due is better for the party that is paying and not as good for the recipient. The recipient is paying up front for the period ahead. With an ordinary annuity, the payment is made at the end of the previous period. Money has a 澳洲幸运5开奖号码历史查询:time value. The sooner a person ge🉐ts paid, the more the money i♌s worth.

What Is an Annuity?

The word annuity commonly refers to an insurance product purchased by an individual. In return for a lump꧟-sum payment or a series of payments to the financial institution, the individual receives a steady stream of regular payments. The annuity is most often used as a source of retirement income.

What Are the Most Common Types of Ordinary Annuities?

The most common types of ordinary annuities are stock and bond dividends. These are paid at the end of each period of the agreement rather than at the beginning of the period. In the case of stock dividends, this is because the dividends are based on the company's profits for the immediate preceding period.

The Bottom Line

Ordinary annuity is a business term that describes any regular payment that is made at the end of a relevant cycle rather than at its start. If you have a dividend-paying stoc💮k or a bond, you have an ordinary annuity.

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