Annuity. It is a world that not many of us hear until we reach a certain point in our career. All of us will eventually have some type of annuity to deal with whether it is ordinary or annuity due. This is why it is important to fully understand what annuity is and how it directly affects us.
Also, how it affects the things that we choose to do with our money. When we are receiving monthly payments from investments or time put in, it’s good to know where we stand. We should not put our dream purchases aside. When understanding annuity, we can use our money smarter. Knowing the total annuity due, you can find out how much you have left to pay. It can also be used to find the total with interest that you will pay.
We often make purchases without thinking about the total with interest. Before we get into the numbers and calculations, let us first clear up a few things about an annuity.
Besides finding out what it is, it is important to note that there are two types. If you’re wondering what those are, we will introduce you to both in just a bit.
What is an Annuity?
Some of you are probably thinking, what on earth is an annuity?
An annuity is essentially a contract between two parties, one of them being an insurance company. There are two types of annuity. One takes a lump sum of money and disburses it back to you regularly. The other collects payments over time that go toward a larger total.
The great thing about an annuity is that it is customizable. You can take choose to have regular payments in any amount or get one entire lump sum all at once.
The first is known as an ordinary annuity and It is taxed just like regular income. These taxes are generally much lower than those for capital gains. The best example of an annuity would be retirement. When the time comes and we have all paid our dues, we take a well-deserved break.
Then, we start collecting retirement, funded by money collected over time. While some can choose to take their lives’ stash of cash, most choose to receive monthly checks.
Monthly payments make it easier to set and keep a budget. You can also choose when you want to start receiving payments, whether it is right away (immediate annuity) or in the very near future (deferred annuity).
The second type is an annuity due. This is most commonly witnessed in a deal between a landlord and a home buyer or when buying a car. Buyers will promise to pay the total of the purchase. They do this by securing a contract with a bank or insurance company.
This contract states the amount per month along with the total number of payments. This is calculated by taking the total amount and dividing it by the time desired for pay off.
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Values of Annuity
We have all heard of interest. It is a great thing if you’ve got money invested that is collecting interest daily. It is a bad thing if you have a huge amount of interest to pay per payment. Anything dealing with money in the form of payment and investments is directly affected by interest. In turn, the total amount or worth of an annuity changes considerably over time.
The key takeaway is that money today is worth more than money tomorrow. This essentially means that $2000 today is going to be worth more than $2000 spread out over three months. Keeping this concept in mind, the most important values to an annuity: present and future.
Present Value of Annuity
When you have an annuity due, knowing its current value is important. This helps you decide if refinancing or pay off is a good option. Knowing your interest helps save you from paying loads of money on interest alone. In order to calculate the present value of an annuity due, you need:
- Number of payments
- Amount of each payment
- Interest rate
As long as you have this information, the rest is plug and push with help from a present value of annuity calculator. You can use a calculator or exercise that high school algebra that you haven’t pulled out in ages. Below is an example using some realistic numbers: payments over 12 months of $5000 each month with an interest rate of 1%.
PV = 5000 × × (1+0. 01) =$56,838.14
Future Value of Annuity Due
Just like the current value of an annuity due, the future value supplies some insights. It helps you choose the best move for you and your money. Knowing the future amount takes interest into consideration and shows, overall, the total amount. This is, the total spent when all is said and done. The formula is as follows where C = payment amount, r = interest rate, and n = number of payments to be made.
FV = C × [ ] × (1+r)
Don’t worry if you’re not a mathematician. There are plenty of sites with annuity payment calculator options. All you do is enter your numbers and you get an instant answer. You can choose a present or future value of an annuity calculator just to be sure.
Then, you can use these figures to make wiser decisions about your investments and future purchases.
Annuity Due: What Can it Tell You?
Making investments and large purchases comes with a lot of doubts. We all want nice things but, we don’t want crippling debt. Taking a step back and doing a few calculations before making your next move can save you. It keeps you from jumping the gun and getting yourself into a situation you may regret.
Once you have a clear amount that will represent the annuity due, you should take a look at the future value. This tells you if your purchase is worth it in the end. It also takes into account the total interest paid.
This is a big help when shopping around. You can compare interest rates quoted to you by different companies and/or banks. Do this to get the best interest rate. You can save yourself and think about whether or not you have the ability to pay off what you owe. Sticking to the goal of clearing up any debts, and wiping your slate completely clean.
They say that time is money and they couldn’t be more right. Often, we get into contracts and are blinded by the material object. We don’t think about what it is costing us in total in the future. When you’ve got an annuity due, it is best to have a good grip on what that will mean.
How it will affect you and all of your future investments and purchases. You have the methods of calculating both the present and future values of an annuity due. Both of these totals come with great insight into how you’re spending your hard-earned cash.
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Understanding the way payments work both with ordinary annuity and annuity due will help you better understand money. It also provides a glimpse into how the world of finance works.
Money makes the world go around, and it is about time we all start to see the true value. Both numbers and percentages, help us make better and more informed choices. It is good to know where we spend our money on what we spend it on.