A 40-year old man from Bellville, Ontario, Derek Schwager received a great deal of online reaction after he won the Cash For Life draw and decided to take the $1.5 million lump sum payout rather than the alternative of $100,000-a-year for life.
Most of his online commentators diverged into two main camps: There were those who argued Mr. Schwager is only 40 years old, and noted that as he got older inflation would reduce the real value of his payments. They also pointed out that after Mr. Schwager had received $2 million, he would have to pay tax on the $100,000 in annual payments.
Others agreed he made a good decision in taking the $1.5 million lump sum up front, and offered some creative ways to invest his winnings. Notwithstanding, any interest payments or gains in this case would be subject to market rates and taxation.
Questions
1. Assume the average life expectancy in Canada is 81 years, and Mr. Schwager lives exactly this long. Using an interest rate of two percent, compounded annually, find the present value for Mr. Schwager of $100,000-a-year.
2. At what age will Mr. Schwager have to start paying tax on his annual payments?
3. If Mr. Schwager had decided to take the $100 000-a-year alternative, what interest rate, compounded annually, would be needed for the two alternatives to be equivalent?
4. If Mr. Schwager had been much older (say 65) or much younger (say 20) do you think his decision would have been different and why?