A Buyer of Structured Settlement Annuity Looks at Time/Value of Money

As a buyer of structured settlement annuity payments, Strategic Capital wants you to be an informed seller. When selling your structured settlement annuity, or advising a client on the sale of theirs, you may wonder about the term “time value of money.” You may think that this idea is somewhat related to inflation and reminiscent of what you may have heard your grandparents say about how a loaf of bread only cost so much when they were young and today’s prices are highway robbery. But actually the time value of money is a bit different, as any buyer of structured settlement annuity payments knows; it is about the idea that a dollar in hand today will be worth more in the future due to potential investment opportunities, yet has value today because it can be used. Let’s examine this in a bit of detail.
 
The Present and the Future

The time value of money is the idea that a dollar today is worth more than a dollar in the future. This is because a dollar received today can earn interest up until the time the future dollar is due to be paid.   If you receive a payment of $1,000 this month, you can invest it, buy things with it, in other words, use it in many different ways.  If you are due to receive a payment of $1,000 in five years’ time, that payment has a value, but as the saying goes, a bird in the hand is worth two in the bush – in this case, a $1,000 this month is worth more than $1,000 in five years, because you can use the $1,000 this month but you cannot use the $1,000 that is due in five years.
 

You can turn the $1,000 you receive this month into cash by depositing the check or wire into your bank account and withdrawing the money. 

 
 
The only way to turn the $1,000 due in five years into cash is to borrow some money today and promise to pay the loan back in five years when you get your $1,000 – or you can sell the right to receive the $1,000 in five years and get cash today.  And the fact that a buyer of structured settlement annuity payments will have to wait five years to be able to turn the $1,000 into cash means that the buyer of structured settlement annuity payments will want to earn a return for waiting five years, and so the buyer will pay you less than $1,000 this month in return for the promise to receive $1,000 in five years.
 
Inflation is Also a Factor

Also remember that inflation is a factor in considering the future value of your money. Inflation is the natural increase in prices that happens in the world today. In the United States, the inflation rate is usually around two percent a year. What this means is that a pack of gum might cost $1 this year and $1.02 next year. Thus, if you have a dollar today that is enough money to buy a pack of gum; but next year that dollar would be insufficient to buy that same pack of gum.
 
How it all Works Together

The time value of money is used to calculate how much you pay to get your settlement turned into cash now, that is how much you get verses how much the buyer of structured settlement annuity gets. Obviously, future money is of less value, due to the time value of money and inflation; this is why the amount that you receive when you sell a structured settlement payment will be less than that entire payment. How much less will depend on how long your payments go into the future.

Published : April 25, 2013

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