How to Calculate the Present Value of the Loss of Future Work Earnings
In a previous blog, I discussed how loss of income benefits are calculated. In general, it’s up to judge or jury to determine how much a person killed would have earned over the remainder of their life, in order to determine the amount of money owed to the survivors. This article discusses a related matter – the time value of money for lost income.
The time value of money is a basic financial principal that money to be paid in the future is worth less than money paid today. For instance, most of us would rather receive $1,000 today than $1,000 one year from now. If we receive the money now, we could invest it, and in a year we would likely have more money (for example, if we could invest the $1,000 at a 10% annual return, we would have $1,100 at the end of a year).
If we keep this amount invested for a second year, we would have $1,210 – we earn slightly more the second year through “compounding” – we earn interest in the second year on the interest earned in the first year. After ten years, $1,000 invested today at a rate of 10%, would grow to approximately $2,593.75 .
In computing lost income, courts and juries must compute a similar adjustment in reverse, as the earnings of a worker over the worker’s lifetime are not paid out all at once at the beginning of the worker’s career, but instead are paid out over many years of work. Thus a yearly salary of $2,593 ten years from now would be worth only $1,000 today if the “discount rate” used is 10%.
The rate used to make these calculations is called the “discount rate” because future earnings are “discounted” (or reduced) to account for the fact that they are being paid now, rather than over the course of years, and can be invested now and grow as illustrated above. The discount rate works exactly the opposite of compounding, as the further in time that a payment is to be made (or a salary received), the less that the payment (or salary) is worth today.
In determining the amount that all of a worker’s future earnings are worth at the present time, it’s necessary to determine how much the worker would have made for the rest of his or her career, and then discount these amounts (using a discount rate). (After being discounted, the amount must then be adjusted upward for the likely inflation that will take place over the period of time involved , but that is complicated and will be the subject of a future article.) The result of these calculations is called the “present value”. The present value of the earnings then represents the amount to which the survivors are entitled.
If you are the survivor of a person wrongfully killed due to the acts or negligence of another, it’s important that you seek qualified legal representation to ensure that you (and other dependents) are fully compensated. Call Bache & Lynch, wrongful death attorneys, if you would like a no obligation, free consultation analysis of your case.