Time Value of Money
Understanding “Present Value” of Future Payments
Often structured settlement holders or lottery winners will express shock at the discounted value of their future payments. This is understandable. While there are certain expenses built into the valuation, a primary factor of the discount is the calculation of the present value of the future payments.
You might expect money that does not yet exist.
What we mean to say is, some of the total amount due you via the annuity is interest. Since that interest has not yet been earned it is not part of the present day value.
On The “amount” of the settlement (ie. the sum of all the future payments) includes a great deal of interest that hasn't been earned yet.
The simple fact of the matter is the promise to pay $100,000 (or any amount) in the future is not worth that amount today. The further in the future it is due, the less it is worth today.
The Time Value of Money
Mortgages are a good example.
If you buy a house and get a mortgage from a bank for $100,000, you will make payments over 20-30 years that might equal closer to $250,000. Some home owners may unfortunately default on their loan and end up in foreclosure. When you exchange your future settlement payments for lump sum cash, you never have to worry about the insurance company defaulting.
You do have to carefully consider the discounted amount you are being offered. You are giving up payments over time that equal more than what a factoring company will pay you. The only reasonable purpose for accepting such a discount is when you are have a pressing financial need or opportunity.
It's the same as with lottery prizes.
If you win the Lottery and select a lump sum you typically receive about one half of the advertised prize amount. In fact, what the lottery commissions do is identical to a structured settlement. An annuity or U.S. Treasury bonds are purchased to fund the future payments due to the winner.
Future payments aren't worth as much as you think.
The further in the future your payment is the less it is worth today. This has a lot to do with inflation. $100,000 today has more buying power than $100,000 in 15 years.
For More information regarding the time value of money,
please send us an email, fill out our form,
or give us a call at 1 800 509 1649.
