**Definition**

An annuity is a series of payments required to be made or received over time at regular intervals.

The most common payment intervals are yearly (once a year), semi-annually (twice a year), quarterly (four times a year), and monthly (once a month).

Some examples of annuities: Mortgages, Car payments, Rent, Pension fund payments, Insurance premiums.

TYPES OF ANNUITIES

**Ordinary Annuity:**

An Ordinary Annuity has the following characteristics:

- The payments are always made at the end of each interval
- The interest rate compounds at the same interval as the payment interval

For calculating the sum of a series of regular payments the following formula should be used:

R[(1+i)^ n -1]

S n = —————–

i

**Example:** Alan decides to set aside $50 at the end of each month for his child’s college education. If the child were to be born today, how much will be available for its college education when s/he turns 19 years old? Assume an interest rate of 5% compounded monthly.

**Solution:**

First, we assign all the terms:

R= $50

i= 0.05/12 or 0.004166

n= 18 x 12, or 216

Now substituting into our formula, we have:

R[(1+i)^n-1]

S n = ——————-

i

$50[(1+0.05/12)^216 -1]

S n = ——————————–

0.05 / 12

S n = $50(349.2020206)

S n = $17,460.10

**Formula for calculating present value of a simple annuity:**

R[1-(1+i)^-n]

A n = ——————–

i

**Example:** Alan asks you to help him determine the appropriate price to pay for an annuity offering a retirement income of $1,000 a month for 10 years. Assume the interest rate is 6% compounded monthly.

**Solution:**

Substituting into our formula, we have:

R = $1,000

i = 0.06 /12 or 0.005

n = 12 x 10, or 120

$1,000[1-(1+0.005)^-120]

A n = ———————————–

0.005

A n = $90,073.45

**Annuity Due:**

In an annuity due, the payments occur at the beginning of the payment period.

For calculating the sum of a series of regular payments the following formula should be used:

R(1+i)[(1+i)^ n -1]

S n (due)= ———————–

i

**Example:** Alan wants to deposit $300 into a fund at the beginning of each month. If he can earn 10% compounded interest monthly, how much amount will be there in the fund at the end of 6 years?

**Solution:**

R = $300

i = 0.10/12 or 0.008333

n = 12 x 6 or 72

Substituting into our formula yields:

$300(1+0.10/12)[(1+0.10/12)^72-1]

S n (due) = ————————————————-

0.10/12

S n (due) = $300(98.93)

S n (due) = $29,679

**Formula for calculating present value of an annuity due:**

R(1+i)[1-(1+i)^-n]

A n(due) = ————————-

i

**Example:** The monthly rent on an apartment is $950 per month payable at the beginning of each month. If the current interest is 12% compounded monthly, what single payment 12 months in advance would be equal to a year’s rent?

**Solution:**

R= $950

i= 0.12/12 or 0.01

n= 12

Substituting into the formula gives:

$950(1+0.03)[1-(1+0.01)^-12]

A n(due) = ———————————————-

0.01

A n(due) = $950(11.37)

A n(due) = $10,801.50