e United States Social Security System offers 62-year-olds with two options: A lifetime real annuity with...

e United States Social Security System offers 62-year-olds with two options:
1. A lifetime real annuity with a specific monthly payment. Monthly payments start
  
  immediately
2. A deferred lifetime real annuity with a higher specific monthly payment. Monthly
  
  payments don’t start until the worker reaches age 67.
Suppose you are a 62-year-old American worker. What factors determine how you decide between the two options?

Expert Solution

In order to compare the 2 options, we'll need to calculate the Present Value of the options, assuming a few variables. The folowing is the formula to calculate the present value.

P (Periodic Payment) is one factor which is important. This is known that payment in second option is higher, but by how much amount, is important to know.

r (rate of return) is another factor (rather the most important factor) which will differentiate the two options. If no rate is given, we can consider the inflation rate of the economy to be r.

n (number of periods) is the third factor to rank the projects. While n is not known, it can be calculated as the difference between the age while start of annuity and the average age of people live in that economy. Suppose, the average age till which people live is 80 years, n = 18 (80 - 62) in case 1 and n = 13 (80 - 67) in case 2.

jeff jeffy answered 1 year ago

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