Annuity in advance definition
/What is an Annuity in Advance?
An annuity in advance is a series of payments that are due at the beginning of each successive time period. Rent and insurance premiums are commonly billed in advance of the periods to which they apply.
Characteristics of an Annuity in Advance
The key characteristics of an annuity in advance are as follows:
Payments at the beginning of the period. The defining feature of an annuity in advance is that payments are made at the start of each interval. For example, rent payments made at the start of each month represent an annuity in advance.
Equal payment amounts. Each payment in the annuity is of the same value throughout the term, ensuring consistency.
Regular intervals. The payments are made at fixed, regular intervals (e.g., monthly, quarterly, annually).
Higher present value. Since payments occur earlier, the present value of an annuity in advance is higher than that of an ordinary annuity with the same payment amount and duration. This is because payments made sooner are discounted less in time-value-of-money calculations.
Higher future value. The future value of an annuity in advance is also higher than that of an ordinary annuity, as each payment has more time to earn interest.
Time period matches payment frequency. The intervals between payments align with the time period used for discounting or compounding (e.g., monthly payments use a monthly interest rate).
Example of an Annuity in Advance
An example of an annuity in advance is a $3,000 monthly rental payment on a property, which is due at the start of the period for which the rent is intended. As the example indicates, payment is due prior to the consumption of what was purchased.
Annuity in Advance vs. Annuity in Arrears
Another form of annuity is the annuity in arrears, where payment is due at the end of each successive time period. The present value of an annuity in advance is always higher than an annuity in arrears, since cash flows occur sooner.
Terms Similar to Annuity in Advance
An annuity in advance is also known as an annuity due.