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SECTION 3.4 Other Simple Annuities

In this section we introduce other simple annuities that can be treated as minor modifications of ordinary
annuities.

Annuities Due

An annuity due is an annuity whose periodic payments are due at the beginning of each payment interval. The
term of an annuity due starts at the time of the first payment and ends one payment period after the date of the
last payment. The diagram below shows the simple case (payment intervals and interest periods coincide) of an
annuity due of n payments.

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It is easy to recognize an annuity due as a “slipped” ordinary annuity, that is, each of the n payments of R has
been moved one period to the left on the time diagram at the beginning of section 3.3. Thus we can simply write
the formulas for the accumulated value S and discounted value A of an annuity due, by adjusting equations (10)
and (11) from sections 3.2 and 3.3.

Since the accumulated value of an annuity was defined as the equivalent dated value of the payments at the end
of the term, it means that the accumulated value S of an annuity due is an equivalent value due one period after
the last payment.

The accumulated value of the payments on the date of the nth payment (which is time n - 1) is . We then
accumulate for one interest period, to obtain

To determine A, we recall that the discounted value of an annuity was defined as the equivalent dated value of
the payments at the beginning of the term. Thus the discounted value of an annuity due is an equivalent value
due at the time of the first payment.

The discounted value of the payments one period before the 1st payment is . We then accumulate for
one interest period to obtain

Actuaries often use the following notation for the accumulated and discounted value of a $1 annuity due:

1. Accumulated value, .

2. Discounted value, .

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EXAMPLE 1Mary Jones deposits $100 at the beginning of each month for 3 years into an account paying j12 =
4.5%. How much is in her account at the end of 3 years?

SolutionWe arrange the data on a time diagram below.

The payments are made from time 0 to time 35 (but there are payments in total). Note how we
wish to determine the accumulated value at the end of 3 years, or time 36, which is one period after the final
payment. Thus we have an annuity due situation.

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We have and calculate

EXAMPLE 2The monthly rent for a townhouse is $1640 payable at the beginning of each month. If money is
worth j12 = 9%,

1. what is the equivalent yearly rent payable in advance,

2. what is the cash equivalent of 5 years of rent?

Solution aWe arrange the data on a time diagram below.

We wish to determine the present value of the 12 payments of $1640 at time 0, which is the same date where the
first payment is made. Thus we have an annuity due.

Solution bWe calculate the discounted value A of an annuity due of 60 payments of $1640 each at j12 = 9%.

In Example 1, if there was a deposit made at the end of 3 years (that is, at time 36), there would be n = 37
deposits in total and the accumulated value at the end of 3 years would increase by $100 to $3961.03. Another
way to obtain this answer is to note that the accumulated value would now be calculated at the time of the 37th
deposit, making it an ordinary annuity:
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We see that

We can generalize this result (with R = 1) as follows:

In Example 2a), we could consider the payment made at time 0 as a down payment and treat the remaining
payments as an ordinary annuity. That is,

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We can generalize this result (with R = 1) as follows:

EXAMPLE 3A debt of $10  000 is due today. However, it is agreed that it can be paid back with 8 quarterly
payments, the first due today. If j4 = 11%, determine the required quarterly payment.

SolutionArranging the data on a time diagram below:

We have A = 10  000, i = 0.0275, n = 8 and calculate R one of two ways:

OR

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EXAMPLE 4You wish to accumulate $20  000 in 5 years' time. To do so, you plan to make 10 semi-annual
deposits, first deposit made today. If you can earn j2 = 6%, what deposit is needed?

SolutionWe have S = 20  000, i = 0.03, n = 10, and the following time diagram:

We calculate R one of two ways:

OR

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Deferred Annuities

A deferred annuity is an annuity with its first payment due some time later than the end of the first interest
period. It is customary to analyze all deferred annuities as ordinary deferred annuities. Thus, an ordinary
deferred annuity is an ordinary annuity whose term is deferred for (let's say) k periods. The time diagram below
shows the simple case of an ordinary deferred annuity.

OBSERVATION:

Note that in the above diagram the period of deferment is k periods and the first payment of the ordinary annuity
is at time k + 1. This is because the term of an ordinary annuity starts one period before its first payment. Thus,
the period of deferment = time of first payment - 1.

To determine the discounted value A of an ordinary deferred annuity we calculate the discounted value of n
payments one period before the first payment and discount this sum for k periods.

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Discounted value one period before first payment (time k)=

Discount factor for k periods =

Thus

If you now return to Exercise 3.3, Part A, you will see that we have already handled questions of this nature
(questions 10 and 14, for example).

EXAMPLE 5What sum of money should be set aside on a child's birth to provide 8 semi-annual payments of
$4000 to cover the expenses for university education if the first payment is to be made on the child's 18th
birthday? The fund will earn interest at j2 = 7%.

SolutionWe arrange the data on a time diagram below.

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We have R = 4000, i = 0.035 per half-year, n = 8, k = 35, and calculate:

EXAMPLE 6Jaclyn wins $100  000 in a provincial lottery. She takes only $20  000 in cash and invests the
balance at j12 = 4% with the understanding that she will receive 180 equal monthly payments with the first one
to be made in 4 years. Calculate the size of the payments.

SolutionThe first payment is due in 4 × 12 = 48 months, so the deferral period is one less, or k = 47.

We have and calculate R from the equation

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CALCULATION TIP:

In general, problems involving any simple annuities can be efficiently solved by applying equations (10) and
(11) for ordinary annuities to find equivalent lump sums and then moving to a requested point in time.

EXAMPLE 7A couple deposits $200 a month in a savings account paying interest at . The first deposit
is made on February 1, 2010 and the last deposit on July 1, 2016.

1. How much money is in the account on

1. January 1, 2014 (after the payment is made)

2. January 1, 2015 (before the payment is made)

3. January 1, 2018?

2. If they want to draw down their account with equal monthly withdrawals from February 1, 2018 to
February 1, 2019, how much will they get each month?

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Solution aWe arrange the data on a time diagram below.

1. We have , and calculate the accumulated value of 48 payments at the time of the 48th
payment (thus we have an ordinary annuity).

2. We have an annuity due and we can calculate the accumulated value of 59 payments.

OR

We can calculate the accumulated value of 60 payments of an ordinary annuity and subtract the last
payment.

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3. We calculate the accumulated value of 78 payments to the time of the 78th payment and then
accumulate this amount for 18 more months.

Solution bUsing result iii) from solution a) the accumulated value of their deposits on January 1, 2018, becomes
the discounted value of their 13 future withdrawals, one month before the first withdrawal. We calculate the
monthly withdrawal,

Forborne Annuities

Forborne annuities are almost the mirror image of deferred annuities. Whereas a deferred annuity has a period of
time before the first payment is made, a forborne annuity has a period of time after the last payment or deposit is
made and before the time when the accumulated value is calculated.

In general, the accumulated value of a forborne annuity consisting of n payments of R, calculated m periods after
the nth payment, is

In Exercise 3.4.B7, you are asked to show that

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The following is an example of a forborne annuity (as is Exercise 3.3.A19 and Example 7a)iii) above).

EXAMPLE 8A family establishes a university savings account on the birth of their daughter. They make
monthly deposits of $100 one month after her birth, continuing up to her 18th birthday (216 deposits in total).

It so happens that the daughter does not go to university at age 18. Instead, she starts to draw monthly payments
from the savings account over 4 years starting on her 23rd birthday. If the savings account earns j12 = 6%,

1. How much money is in the account on her 23rd birthday?

2. What is the size of the monthly withdrawal starting on her 23rd birthday?

Solution aThe first deposit is made one month after the birth of the child and the final deposit is made at time 18
years × 12 = 216. Thus, n = 216.

We want the accumulated value on the daughter's 23rd birthday, or time 23 × 12 = 276, which is 276 - 216 = 60
months after the final deposit. Thus, m = 60.

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Alternatively,

Solution bThe first withdrawal is made on the daughter's 23rd birthday and continues for n = 48 months. Thus,
we have an annuity due with A = 52 248.14. If the monthly withdrawal is R, then

Using a Financial Calculator for Annuities Due

For calculating periodic payments, accumulated or discounted values of an annuity due, you need to make sure
your BA-II Plus calculator is in BGN mode (BGN stands for “payments at the beginning of each period”). To do
this, hit the 2ND key and press BGN. If your calculator reads END, then hit the 2ND key and press SET. Your
calculator should now read BGN. Then press the CE/C button. You then follow the exact same steps as given in
sections 3.2 and 3.3.

The following illustrates the proper calculator entries for calculating the accumulated value of the annuity due in
Example 1:

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The following illustrates the proper calculator entries for calculating the discounted value of the annuity due in
Example 2a):

The following illustrates the proper calculator entries for calculating the quarterly payment in Example 3:

Using a Financial Calculator for Deferred Annuities

You must first get out of BGN mode by pressing the 2ND key and then pressing BGN. If your calculator reads
BGN, hit the 2ND key and press SET. The calculator should now read END. Press the CE/C key. You must also
have set up your equation of value so that you know the value of n (term of the annuity) and k (deferral period).
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The process is to first calculate the discounted value of the annuity and then discount that value k periods. The
following illustrates the proper calculator entries for calculating the discounted value of the deferred annuity in
Example 5:

After this calculation, you add a negative sign to your answer and then push the FV key (as -$27  495.82215
represents the future value of your annuity that is supposed to start k = 35 periods earlier). The full sequence is:

Exercise 3.4 Part A

1. Determine the discounted value and the accumulated value of $500 payable semi-annually at the
beginning of each half-year over 10 years if interest is 8% per annum payable semi-annually.

Answers

2. A couple wants to accumulate $10  000 by December 31, 2023. They make 10 annual deposits starting
January 1, 2014. If interest is at j1 = 2%, what annual deposits are needed?

3. The premium on a life insurance policy can be paid either yearly or at the beginning of each month. If the
annual premium is $120, what monthly premium would be equivalent at j12 = 5%?

Answers

4. Deposits of $350 are made every 3 months from June 1, 2014, to June 1, 2017. How much has been
accumulated on September 1, 2017, if the deposits earn j4 = 6%?

5. An insurance policy provides a death benefit of $100  000 or payments at the beginning of each month for
10 years. What size would these monthly payments be if j12 = 5.5%?

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6. A used car sells for $9550. Brent wishes to pay for it in 18 monthly instalments, the first due on the day of
purchase. If 12% compounded monthly is charged, determine the size of the monthly payment.

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7. A real estate agent rents office space for $5800 every 3 months, payable in advance. He immediately
invests half of each payment in a fund paying 9% compounded quarterly. How much is in the fund at the
end of 5 years?

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8. A refrigerator is bought for $60 down and $60 a month for 15 months. If interest is charged at ,
what is the cash price of the refrigerator?

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9. Determine the discounted value of an ordinary annuity deferred 5 years paying $1000 a year for 10 years
if interest is at j1 = 8%.

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10. Determine the discounted value of an ordinary annuity deferred 3 years, 6 months that pays $500 semi-
annually for 7 years if interest is 7% compounded semi-annually.

11. What sum of money must be set aside at a child's birth to provide for 16 quarterly payments of $2500 to
cover the expenses for a university education if the first payment is to be made on the child's 18th birthday
and interest is at j4 = 5%?

Answers

12. On Mr. Pimentel's 55th birthday, the Pimentels decide to sell their house and move into an apartment.
They realize $350  000 on the sale of the house and invest this money in a fund paying j1 = 4%. On Mr.
Pimentel's 65th birthday they make their first of 15 annual withdrawals that will exhaust the fund. What is
the dollar size of each withdrawal?

13. Mrs. Howlett changes employers at age 46. She is given $85  000 as her vested benefits in the company's
pension plan. She invests this money in an RRSP (Registered Retirement Savings Plan) paying j1 = 8%
and leaves it there until her ultimate retirement at age 61. She plans on 25 annual withdrawals from this
fund, the first withdrawal on her 61st birthday. Determine the size of these withdrawals.

Answers

14. Determine the value on January 1, 2014, of quarterly payments of $100 each over 10 years if the first
payment is on January 1, 2016, and interest is 7% compounded quarterly.

15. Determine the value on July 1, 2014, of semi-annual payments of $500 each over 6 years if the first
payment is on January 1, 2018, and interest is at payable semi-annually.

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16. The XYZ Furniture Store sells a chesterfield for $950. It can be purchased for $50 down and no payments
for 3 months. At the end of the third month you make your first payment and continue until a total of 18
payments are made. Determine the size of each payment if interest is at j12 = 18%.

17. An 8-year-old child wins $1  000  000 from a lottery. The law requires that this money be set aside in a
trust fund until the child reaches 18. The child's parents decide that the money should be paid out in 20
equal annual payments with the first payment at age 18. Calculate these payments if the trust fund pays
interest at j1 = 5%.

Answers

18. The Smiths deposit $500 at the end of each month for 25 years to fund a 20-year retirement annuity, with
the first withdrawal made exactly 5 years after the last deposit of $500. Calculate the monthly retirement
withdrawal if

1. the interest rate is j12 = 6% throughout.

2. the interest rate is j12 = 7.2% for the investment growth period and j12 = 4.2% at the time of the first
retirement withdrawal.

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Part B

1. A man aged 40 deposits $5000 at the beginning of each year for 25 years into an RRSP paying interest at
j1 = 7%. Starting on his 65th birthday he makes 15 annual withdrawals from the fund at the beginning of
each year. During this period (i.e., from his 65th birthday on) the fund pays interest at j1 = 6%. Determine
the amount of each withdrawal starting at age 65.

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2. Jacques signed a contract that calls for payments of $500 at the beginning of each 6 months for 10 years.
If money is worth j2 = 3%, determine the value of the remaining payments

1. just after he makes the 4th payment;

2. just before he makes the 6th payment.

3. If after making the first 3 payments he failed to make the next 3 payments, what would he have to
pay when the next payment is due to bring himself back on schedule?

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3. Using a geometric progression, derive the formula for the accumulated value S of an annuity due

Show that it is equivalent to

4. Using a geometric progression derive the formula for the discounted value A of an annuity due

Show that it is equivalent to

5. A mutual fund promises a rate of growth of 10% a year on funds left with it. How much would an investor
who makes deposits of $1000 at the beginning of each year have on deposit by the time the first deposit
has grown by 159%? You may assume that the time is approximately an integral number of years and that
the investor is about to make, but has not made, an annual deposit at that time.

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6. Show that the discounted value A of an ordinary deferred annuity is equivalent to

7. Show that .

8. Show that .

9. Starting on his 45th birthday, a man deposits $10  000 a year in an investment account that pays interest at
j1 = 3%. He makes his last deposit on his 64th birthday. On his 65th birthday he transfers his total savings
to a special retirement fund that pays . From this fund he will receive level payments of $X at the
beginning of each year for 15 years (first payment on his 65th birthday). Determine X.
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Answers

10. Given the following diagram

determine simplified expressions for a single sum equivalent to the seven payments calculated at times 1,
5, 8, 12, and 15, assuming rate i per period.

11. Provide symbolic answers (using , , i) in simplified form for the value of the following payments at
the time indicated, assuming rate i per payment period.

1.

2.

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12. Deposits are $100 per month for 3 years, nothing for 2 years, and then $200 per month for 3 years. Interest
rates start at j12 = 8% and fall to j12 = 6% on the date of the first $200 deposit. Determine the accumulated
value at the time of the final $200 deposit.

13. The present value of an annuity of $1000 payable for n years commencing one year from now is $6053.
The annual effective rate of interest is 12.5%. Determine the present value of an annuity of $1000
commencing one year from now and payable for (n + 2) years.

Answers

14. A person deposits $100 at the beginning of each year for 20 years. Simple interest at an annual rate of i is
credited to each deposit from the date of deposit to the end of the 20-year period. The total amount thus
accumulated is $2840. If, instead, compound interest had been credited at an annual effective rate of i,
what would the accumulated value of these deposits have been at the end of 20 years?

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