Question

You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years. You can earn 10 percent on your money. Which option should you take and why?

Answer 1

We have to compare both options at a single point of period, which will be now for this case.

Option 1: Lump-sum Payment

Value now = $200,000

Option 2: Annuity of $1,400 a month for 20 years

PVA = Annuity x [{1 - (1 + r)^-n} / r]

= $1,400 x [{1 - (1 + 0.10/12)^-(20*12)} / (0.10/12)]

= $1,400 x [0.8635 / 0.0083] = $1,400 x 103.6246 = $145,074.47

As the value of the lump-sum option is higher, so we should take this option.