Most of the families we serve are not NCAA athletes at power conference schools, but many are fans and season ticket holders. They are more likely to be athletic boosters than athletic legends, starting with yours truly! But we all inhabit the same financial landscape and use the same tools to make decisions. I hope our families with eyes more focused on retirement will enjoy a brief detour this week as we apply our analytical toolbox for a group they are used to seeing on ESPN.
Time Value of Money
Everyone who wants to create wealth for themselves and their family needs to understand the time value of money. If this is a new concept to you, it helps to think in extremes. If I offer a choice between $1,000 today or $2,000 in 20 years, everyone will take the cash today, knowing that they could reliably double their money in 20 years. We can perform time value of money calculations to turn this hunch into an apples-to-apples comparison. Say we believe we can earn 8% on our money each year, that $2,000 in 20 years is only worth $429 to us today.
Classic Example for Retirees
Time value of money calculations is instrumental for people who have earned a pension. They often can choose a lump-sum at retirement or receive a stream of payments for life. As planners, we always compare the options to make sure one is not especially attractive. Just a few years back, near-zero interest rates made lump-sum elections a slam dunk for some retirees.
NIL- A New, Temporary “Pension”
Thanks to the shifting landscape of college sports and recent litigation, former athletes are becoming entitled to settlement payments for the use of their likeness during their careers. Some of these payments are to be paid over a ten year period with no option to choose a lump sum. However, private companies have sprung up offering as little as 40 cents on the dollar to purchase the athletes’ rights to a 10 year stream of payments.
Let’s Do the Math
Imagine you are a former athlete in your late 20’s entitled to $100,000 in the form of 10 annual payments of $10,000. Let’s say you instead sell those rights to a third party for a one-time lump sum of $40,000 today. You would have to earn 10.72% per year to get to $100,000 in ten years. However, that doesn’t account for the fact that if you received the annual payments, you could also invest those at a similar rate. The true time value of money calculation would require earning 30.24% PER YEAR on your lump sum to finish with equal wealth.
From the purchaser’s side, as long as their cost of capital is less than 21.41% annually, this offer generates positive net present value.
A Raw Deal
If we sat across the table from a retiring client with an offer to buy out their pension with these terms, we would NEVER let them opt into the lump sum. Anyone who can use a financial calculator can see that such an offer is borderline predatory. Unfortunately, these recently graduated athletes, who never had an opportunity to earn during their athletic careers, are now fielding these offers from pop-up Delaware LLCs ready to bilk them out of their settlement funds. My hope for them, the same as I have for the families we serve, is that each athlete will find wise counsel to steer them away from these opportunists.