A quote attributed to Albert Einstein talks about compound interest: “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.”
While there is some question to the authenticity of the quote, one thing is for sure—compound interest (earning interest on accumulated interest) can have a big impact on investments. It is also an important foundational element of structured settlements.
For example, a 35-year-old male decides to place part of his settlement into a lifetime annuity. The annuity he selects pays out $1,000 per month for life with a 20-year guarantee, compounding annually at 2%. If he lives his normal life expectancy of 46 additional years, he will receive a total of $892,967, tax-free. The actual cost of the annuity is $520,000 so he will have earned an additional $372,967 in tax-free interest just because of the compounding effect.
For individuals who must make their settlement last a lifetime, having the settlement proceeds compound safely and tax-free in a guaranteed structured settlement annuity could mean tens of thousands of dollars in additional income over time.
Structures Versus Lump Sum Payments. Compound interest plays a big role when deciding between structuring a settlement and receiving the settlement upfront in a lump sum payout. While proceeds received as a lump sum can compound, unless the money is placed in tax-free government securities, the interest earned is taxable. Taxes can cut into the real rate of return. The investment proceeds can also be subject to market fluctuations.
There are certainly many options to consider when it comes to dispersing settlements proceeds. Each individual’s situation is unique. For questions about structured settlements, please feel free to give me a call.—Pat