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Annuity Due

Prudent financial planning often involves considering various investment options to secure one’s financial stability. Annuities are a popular choice for individuals seeking a steady income stream over a specified period. 

Annuities are of many types, including - fixed annuities, variable annuities, immediate annuities, and deferred annuities. Among these, one notable variant is the annuity due. In this article, we will discuss what annuity due is, understand annuity due meaning, its formula, and how to calculate its value.

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Annuity Due

What is Annuity Due?

Annuity Due
September 10, 2024

Table of Content

 

What is Annuity Due?

An annuity due is a financial arrangement under which payments are made or received at the beginning of each period. To understand what an annuity due is, one must remember that it is different from a regular annuity. One of the key features of annuity due is that payments are made or received at the beginning of each period, while in the case of a regular annuity, payments occur at the end of the period.

Annuity due is commonly used for investments, loan amortization, or retirement planning. It offers a regular income stream for a predetermined duration.

Since the annuity payments involve money you will receive or pay in the future, it is crucial to determine their total value. This is important considering the time value of money. You can do this by calculating the present value. You can use a table to calculate the present value of annuity-due payments.

A life annuity due, often offered by insurance companies, means you start receiving or paying money at the beginning of each month, quarter, or year, instead of at the end. This type of Annuity Plan keeps paying you as long as you are alive. Any leftover money goes back to the insurance company when you pass away.

Annuity Due Formula?

The annuity due formula for calculating the present value (PV) or the future value (FV) of an annuity due is as shown below:

PV Annuity Due = C x [ 1-(1+i)-n / i ] x (1+ i)

FV Annuity Due = C x [ 1-(1+i)n / i ] x (1+ i)

Where:

  • C = Cashflows per period 

  • i = Interest rate per period

  • n = Number of periods

Let us take an example to understand this better. Suppose an annuitant is to immediately receive INR 1000 every year for the next 10 years at an annual interest rate of 5%. Now if the person wants to assess the present value of this stream of payments, they will use the PV annuity due formula as follows:

PV Annuity Due = 1000 x [ 1-(1+.05)-10 / .05 ] x (1+ .05)

Similarly, if the annuitant wants to assess the future value of the stream of payments, they will use the FV annuity due formula as follows:

FV Annuity Due = 1000 x [ 1-(1+.05)10 / .05 ] x (1+ .05)

Calculating the Value of an Annuity Due

Determining the present value (PV) and future value (FV) of an annuity due involves mathematical calculations based on the annuity due formula mentioned above. These calculations help individuals understand the worth of their investment at different points in time.

Present Value of an Annuity Due

The present value of an annuity due indicates the current worth of all the future payments you will either receive or make. This formula takes into consideration the time value of money for assessment. It tells you how much those future payments are worth in present-day terms.

Future Value of an Annuity Due

The future value of an annuity due indicates the total value of all the payments you will either receive or make in the future. This formula assesses on the consideration that those payments will either earn or accrue interest over time. It is basically, estimating how much your investment will grow in the future.

Tax Implications of Annuity Due

In India, the purchase price of assets, including investments like annuity due, are adjusted for inflation using indexation. This adjustment helps the taxpayers to account for the decreasing purchasing power of their money over time, caused by increasing inflation. This approach is useful when calculating taxable gains.

To compute the tax implications of an annuity due in India, indexation is applied to the cost of acquiring the annuity. Here is how this works:

  • Firstly, the indexed cost of acquiring the annuity due is calculated. This is done by adjusting the original purchase price of the annuity against the cost inflation index (CII). 

  • Once the indexed cost is known it is subtracted from the sale proceeds of the annuity to find out the taxable gain. 

  • Tax is levied on this gain as per the tax rate applicable. 

  • Another factor to consider here is whether the annuity due is a short-term capital gains investment or a long-term capital gains investment, as they are both taxed at different rates.

Indexation helps to reduce the taxable gain by taking into consideration the impact of inflation and lowering the tax liability. 

FAQs on Annuity Due

Q. What is life annuity due?

A life annuity due is a type of annuity that provides regular payments for the complete life of an individual life. The payments, in this case, begin immediately.

Q. What happens when an annuity comes due?

When an annuity comes due, the annuitant either receives a lump sum payout or continues to receive periodic payments. This depends upon the terms of the contract.

Q. What is the difference between ordinary annuity and annuity due?

The major difference between the two lies in the timing of payments. In an ordinary annuity, payments occur at the end of each period. On the other hand, in an annuity due, payments occur at the beginning of each period.

Q. What is the concept of annuity?

An annuity is a financial product that offers regular payments over a specified period to an annuitant. It is often used for retirement planning or investment purposes.

Q. How do I get my money back from an annuity?

The method for withdrawing funds from an annuity depends on its contract terms. Options can be either receiving periodic payments or withdrawing a lump sum.

Q. Is the annuity due or immediate?

An annuity due starts payments immediately, while an immediate annuity begins payments after a short deferral period.

Conclusion

The annuity due is a valuable financial tool. It works primarily for those seeking a predictable income stream over a specified period. If you understand the workings of this insurance product, including its formula and methods for calculating its value, you will be able to make informed financial decisions. In addition, one must understand the tax implications. It is good to remember the role of indexation in adjusting for inflation when calculating taxable gains. This adjustment helps reduce the tax burden on the annuitant.

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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