An annuity payable is an investment or loan where payments are made at the beginning of each period. The time value of money demonstrates the effects of interest on money saved over time. An annuity due can increase returns, but taking payments at the beginning of each year can result in a loss of interest income. However, using an annuity due for loan payments can save interest and increase wealth.
An annuity payable is an annuity instrument in which payments are made over a specified period of time at the beginning of each period. This type of instrument can be an investment or a loan, depending on its purpose and who owns the annuity. Examples of annuities include savings accounts, insurance policies, home loans, and other similar investments. The key point of an annuity payable is that payments occur at the beginning of the period, which plays a significant role in the concept of the time value of money.
The concept of the time value of money demonstrates the effects of interest on money saved over a period of time. Banks and other financial institutions offer interest to individuals and businesses as a way to save money rather than spend it right away. This concept requires the present value of the initial investment, the payments added to the initial balance, the interest rate and the term of the investment. Using a basic time value calculation, the future value of money is calculated. This formula can also calculate the present value of an annuity owed by using this formula in reverse.
For example, suppose the following: An investor places $10,000 US Dollars (USD) into a savings account with an interest rate of 5%. No additional payments are added to your initial balance and the money will stay in your account for 10 years. The investor will receive payments at the beginning of each year because the investment is an annuity due. Based on the formula, your annual payments will be $1,233.38 USD. Conversely, assume the information is the same, but the investor uses a regular annuity, where payments are made at the end of each year. The investor will receive payments of $1,295.05 USD each year, increasing the return on investment by $61.67 USD each year. The difference refers to the interest lost by taking payments at the beginning of each year rather than at the end, resulting in a loss of interest income.
While an annuity due seems unfavorable in terms of the savings account of other investments, imagine if the payments were made on a mortgage or other loan. Using the same information as in the previous example, investors would save $61.67 USD in interest payments by making loan payments at the beginning of each year rather than at the end. Over the 10-year loan period, an individual would save $616.70 USD in interest using an annuity owed. This money could be reinvested to earn additional interest and increase an individual’s wealth rather than reduce it.
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