by John Darer® CLU ChFC MSSC RSP CLTC
What is present value and how does present value relate to a structured settlement?
The time value of money is how much money is worth if earning a given amount of interest over a given amount of time.
If you invest $100,000 into a 30 Year United States Treasury Bonds at 4.12% and hold them to maturity, in 30 years your portfolio is worth $335,756.77. As the website Girls Just Wanna Have Funds states: "Compound Interest Is Your Friend: Make Her Work For You!" The pot of gold at the end of the rainbow is its future value
If someone wants to buy your property and says they will give you " a big lump sum" of $335,756.77 in 30 years with no payments today, what is that future sum worth to you today? What is its present value?
The present value is a product of the discount rate used
If you receive $335,756.77 in 30 years and you assume a 4.12% discount rate, all things being equal to the above example for future value, then your present value is $100,000.00.
On the other hand if you had money in hand today and a comparable investment were available on which you could earn 6%, then if discount rate of say 6% were used then the present value would be lower. Conversely if a discount rate of lower than 4.12% were used the present value would be higher.
The above are examples of present value in relation to a lump sum to be received in the future, but you can also easily calculate the present value of an income stream. It might be useful for example, if you were comparing two contract offers for an athlete that included deferred bonuses paid in different amounts at different times.
Time value of money calculations have alot of application in the structured settlement and settlement planning arena.
- A component to determining the economic value of damages
- Valuing a life care plan.
- Performing the analysis required for a CPLR 50A or CPLR 50B judgment in New York to determine interest and attorney fees and everything resulting therefrom, including the cost to fund the judgment.
- Determining the value to assign to structured settlement payments remaining upon the annuitant's death for estate tax purposes
- Determining the value to assign to structured settlement payments remaining upon the annuitant's death to determine the amount to be paid to a surviving payee under a commutation rider.
- Comparing structured settlement quotes with different cash flows.
- Determining the factoring discount for a structured settlement factoring transaction (i.e. you are selling structured settlement payment rights that you own, or buying them from someone else as an investor.
From time to time, consumers, financial writers and even judges inadvertently muddle future value with present value. We're here to help our clients and the judiciary better understand the numbers when time value of money comes into play.
Last updated October 2, 2023