Synergy Blog

Settlement Planning – What is IRR and Does It Matter?

By Anthony F. Prieto, Jr., CFP(R)

At Synergy, we spend a lot of time in mediations helping attorneys and their seriously injured clients to plan for their post settlement future.  We try to create holistic settlement plans that meet our client’s needs while taking the least possible amount of risk.  The majority of financial products in the settlement industry are fixed income or fixed interest products.  To keep it simple, I will only be discussing fixed rate products below.

A commonly asked question about fixed interest products, such as a structured settlement annuity, is what is the rate?  That is hard to explain because it’s not always comparing apples to apples when you look at investment returns among different products.  I took the most commonly used terms in the financial industry and went to www.investopedia.com for definitions.  Below are the simple form definitions from that site:

Yield:

The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.

Nominal Rate of Return:

The amount of money generated by an investment before expenses such as compounding periods, taxes, investment fees and inflation are factored in.

Effective Rate of Return:

An investment’s annual rate of interest when compounding occurs more often than once a year.

Internal Rate of Return (IRR):

The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero.

Tax Equivalent Yield (TEY):

The equivalent yield on a taxable investment when an investor’s tax rate is considered.  (The higher your tax bracket the more this will impact your rate.)

Pretty simple right?  To make matters worse, structured settlement annuities typically have both guaranteed and expected returns listed on the proposals.  The Internal Rate of Return (IRR) which is shown on the proposal is based on life expectancy.  Different life companies use different life tables to determine life expectancy.  As a result, the exact same proposal from two different life companies could show two different internal rates of return.  It is important to know that the IRR shown on a structured settlement quote is a composite rate.  It takes into consideration that short payments receive less interest than the longer payments.

What should you do?  First, recognize that the rate is not necessarily as important as creating a plan that meets your needs.  Second, find an expert that will take the time to thoroughly explain these issues and assist you in arriving at an educated decision.  There are many options in terms of managing monies recovered as a result of a personal physical injury.  Knowing the options and focusing on solutions rather than rates will result in a plan that ultimately meets the primary objective of having a good investment solution which also meets critical life needs post settlement.

Synergy provides comprehensive settlement planning/consulting services.  We offer unique solutions to meet the needs of our clients.  Find out more today about how Synergy can make a difference.  Visit our consulting site at www.synergysettlementconsulting.com

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