Annuity Due

What is Annuity Due?

To properly understand Annuity Due, it is helpful to first establish a clear understanding of what an Annuity is. An annuity is a sequence of payments made at consistent intervals, and the timing of these payments is key to differentiating various types of annuities. There are different types of Annuities, such as Fixed, Variable, Immediate, and Deferred Annuities. Annuity Due is one of the noteworthy variants among these types like Annuity in NPS.

With an Annuity Due, payments are made at the start of each period. A common example is rent: you pay at the beginning of the month to secure your tenancy. Whereas, an ordinary annuity has payments due at the end of each period. Loan repayments are a good example of ordinary Annuity. You receive the loan initially and then make regular payments, typically at the end of each month.

Annuity Due provides a regular income stream for a specific timeframe and is often used for investments like retirement plans or financial products involving lease agreements and insurance payouts.

How Annuity Due Works?

The key characteristic of an Annuity Due is that payments are made at the start of each period, unlike a regular annuity, where payments occur at the end. For the recipient, these payments represent a (legal) asset, while for the payer, they constitute a (legal) debt liability requiring regular payments.

To properly assess the value of future annuity payments, we must consider the time value of money. Present value calculations address this, effectively showing the current worth of those future cash flows.

A life Annuity Due, a common insurance product, features payments that begin at the start of each period (monthly, quarterly, or annually). This guarantees a lifetime income stream, but any remaining balance reverts to the insurance company after the annuitant’s demise.

Annuity Due Formula

To calculate the value of the due Annuity, you can use the formula and get an approximation of the Annuity Due value. To get the value, you need to know the present and future values of the Annuity Due, which is calculated using the following formulas:

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

Where,

PV= Present value

C= Cashflows per period

i = Interest rate per period

n = Number of periods

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

Where,

FV= Final value

C= Cashflows per period

i = Interest rate per period

n = Number of periods

Calculating the Value of an Annuity Due

While retirement calculator is used to calculate retirement pension, Annuity Due is calculated using a formula. To understand the current (present value, PV) and future (future value, FV) worth of an Annuity Due, we use dedicated formulas. These calculations are crucial for assessing the value of the investment over time.

Let us take this example where an annuitant is to immediately receive ₹5000 every year for the next 10 years at an annual interest rate of 5%. To determine the present value of this series of payments, they would use the present value of an Annuity Due formula as follows:

PV Annuity Due = 5000 x [ 1-(1+.05)-10 / .05 ] x (1+ .05)

Likewise, to calculate the future value of the same stream of payments, they would use the future value of an Annuity Due formula:

FV Annuity Due = 5000 x [ (1+.05)-10/- 1 / .05 ] x (1+ .05)

Present Value of an Annuity Due

The present value of an Annuity Due tells us the current value of a series of expected Annuity payments. In other words, it shows what the future total to be paid is worth now.

While the present value calculations for Annuity Due and ordinary Annuities share similarities, the timing of payments creates a crucial distinction. In an Annuity Due, payments are made at the start of each period; in an ordinary Annuity, they are made at the end. You can get the present value of an Annuity Due by the formula:

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

Future Value of an Annuity Due

The future value of Annuity Due shows you what your payments will be worth later. And just like with present value, there’s a difference in how you calculate future value for annuities due versus regular ones. The formula for calculating the future value of an Annuity Due is:

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

Tax Implications of Annuity Due

To determine the tax implications of an Annuity Due in India, indexation is applied to the investment cost. The process is as follows:

• The indexed cost of purchase is calculated. This involves adjusting the original purchase price of the Annuity using the Cost Inflation Index (CII).
• Once the indexed cost is determined, it is subtracted from the sale returns of the Annuity to arrive at the taxable gain.
• This gain is then taxed according to the applicable tax rate.
• It’s important to differentiate between short-term and long-term capital gains, as they are taxed at different rates. This classification depends on the holding period of the Annuity Due.

Indexation effectively mitigates the taxable gain by factoring in the impact of inflation, thus reducing the overall tax liability.

FAQs on Annuity Due