Loading the player...

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. While the payments in an annuity can be made as frequently as every week, in practice, ordinary annuity payments are made monthly, quarterly, semi-annually or annually. The opposite of an ordinary annuity is an annuity due, where payments are made at the beginning of each period.

BREAKING DOWN 'Ordinary Annuity'

Examples of ordinary annuities are interest payments from bond issuers, which are generally paid semi-annually, and quarterly dividends from a company that has maintained stable payout levels for years. The present value of an ordinary annuity is largely dependent on the prevailing interest rate. Because of the 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 the annuity is based on the return you can get elsewhere. If you can get a higher interest rate somewhere else, the value of the annuity in question goes down.

Present Value of 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

Given these variables, the present value of an ordinary annuity is:

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

For example, if an ordinary annuity pays $50,000 per 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) / 0.05) = $205,010.

Present Value of Annuity Due Example

Recall that with an ordinary annuity, the investor receives the payment at the end of the time period. This stands in contrast to an annuity due, where the investor receives the payment at the beginning of the period. This impacts the value of the annuity. The formula for an annuity due is slightly different 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, the present value of it 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 is always worth more.

RELATED TERMS
  1. Annuity Due

    An annuity whose payment is to be made immediately, rather than ...
  2. Present Value Of An Annuity

    The current value of a set of cash flows in the future, given ...
  3. Future Value Of An Annuity

    The value of a group of payments at a specified date in the future. ...
  4. Annuity In Advance

    An amount of money that is regularly paid at the beginning of ...
  5. Delayed Annuity

    An annuity in which the first payment is paid at a later date ...
  6. Annuity In Arrears

    An annuity that has periodic payments of either interest and/or ...
Related Articles
  1. Investing

    What's an Ordinary Annuity?

    An ordinary annuity is a series of equal payments made at the end of each period over a fixed amount of time.
  2. Retirement

    How to Calculate the Value of Annuities

    Here's everything you need to account for when calculating the present and future value of annuities.
  3. Retirement

    Are Annuities Retirement-Only Investments?

    Learn more about why annuities are generally purchased and the way that they can positively and negatively affect an individual preparing for retirement.
  4. Investing

    DIY Annuities: What You Need to Know

    Annuities are attractive because they can give you a stream of income, but they can be tricky to buy.
  5. Retirement

    Who Benefits From Retirement Annuities

    Annuities guarantee some degree of fixed income in retirement. But is the security worth the fees and less favorable tax treatment? How to decide.
  6. Retirement

    How a Fixed Annuity Works After Retirement

    These popular investments can provide a steady stream of income during your retirement years. Here are the details.
  7. Financial Advisor

    Annuities: A Good Option in Turbulent Times?

    Annuities can be an enticing option as Americans near retirement, but there are several reasons to be wary of them.
  8. Retirement

    Taking The Bite Out Of Annuity Losses

    If this investment product has caused you sleepless nights, it's time to consider alternatives.
  9. Financial Advisor

    Annuities: The Good, Bad and the Ugly

    Annuities suffer from a few perception problems. This primer that covers the good, the bad and the ugly of annuities.
  10. Retirement

    Guaranteed Retirement Income In Any Market

    By laddering annuities, you can be sure you'll have income no matter what the market does.
RELATED FAQS
  1. How do I calculate the future value of an annuity?

    Find out how to calculate the future value of an ordinary annuity or an annuity due, including how the power of compounding ... Read Answer >>
  2. For what types of financial instruments would I want to calculate the present value ...

    Learn about the types of financial instruments the present value of an annuity calculation is most useful for, including ... Read Answer >>
  3. What are the risks of annuities in a recession?

    Distinguish between the most common types of annuities, and understand which types of annuities pose the most risk during ... Read Answer >>
  4. What is the difference between the present value of an annuity and the future value ...

    Find out about the difference between the future value and present value of a fixed annuity, including how to use these calculations ... Read Answer >>
Hot Definitions
  1. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  2. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  3. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  4. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  5. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  6. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
Trading Center