NPV (Net Present Value) Basics

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We also field a lot of questions on NPV … what it is, why a participant in a divorce should care about it, and how one can calculate it.  here’s an article about student loans that has a better explanation of NPV than any of the mumbo-jumbo I have seen from experts in the pension valuation field:

Net Present Value (NPV) is a way of comparing the value of money now with the value of money in the future. A dollar today is worth more than a dollar in the future, because inflation erodes the buying power of the future money, while money available today can be invested and grow.

The term constant dollars refers to the net present value relative to a fixed date. The term current dollars refers to the unadjusted value of the money. The term discount rate refers to a percentage used to calculate the NPV, and reflects the time value of money.  Full Article Here:

NPV come into pensions and division of property for divorce in two distinct ways.  The first way is deciding the value of one or both litigant’s pensions when these pensions are some distinct value.  If one of the partners has a pension that will pay some fixed value at age 60, and the person is only 40 years old now, it should be pretty easy to see that if the couple wants to trade off assets now to divide their estate, the value of that pension at age 60 is certainly not the same as it is today.  The referenced article gives a good synopsis of how an actuary might analyze the value.

The second situation is more common when dealing with CSRS, FERS or military pensions.  These pensions will increase in value as the employee continues in service and gains advancement in rank or pay grade. The civil service pensions also have set amounts that the employee has contributed over the years.  this is the value of the employee’s contributions, it is not, by any means the current or future value of the pension.  Many times a divorce has been settled by taking the employed person’s cash contributions out of the fund and dividing them.  This is almost never the way to go.  Suppose a CSRS employee has $60,000 in his contribution account.  The lawyers decide to have him withdraw $30,000 as the wife’s share … she gets a check and everyone is happy.  Bad, bad move.

That pension may well have a net present value of $200,000 and the wife’s share might well be 50%.  In a case like this the husband would be ‘getting away with murder’ and the spouse, temporarily happy with her cash windfall might later be after her attorney with malpractice in her eye.

It’s absolutely essential to calculate the NPV of pensions accurately before deciding how to divide the property.  And essential that competent legal, actuarial and tax guidance be sought. To do any less is to potentially cheat oneself or others.  The fees for conducting a NPV analysis are tiny in comparison to the money that may be at risk.

As always this is lay advice offered for information only, do not rely upon it but only upon the advice of a competent professional.

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2 comments on “NPV (Net Present Value) Basics

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