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Question: My spousal support present value calculation does not match yours. Why not?

Answer: Most likely, it is because we are taking account of taxes on the income earned on the spousal support payments. A financially-equivalent way of saying this is that we are using an after-tax interest rate.

The following example will illustrate both perspectives.

Consider the following situation:
Spousal Support Payment: $15,000/month for 120 months
Pre-tax discount rate (e.g., 20-year treasury bill rate): 3%
Tax rate: 25% federal + 10% state

The after-tax value monthly income you get from the 15,000 pre-tax payment is $15,000 * (1.0-(0.25+0.10)) = $9,750.

We want to discount this stream of payments to present value. The question is, what interest rate should we use to discount these payments?

The tendency is to use 3%, our 20-year treasury bill rate.

Discounting at 3%,we would get a present value of $1,553,426. You can duplicate this, as follows. Into Excel or Google Spreadsheet, type:
=pv(0.03/12,120,15000)
(The 0.03/12 gives the monthly interest rate, for which we are using 1/12 of the annual rate.)

However, this approach ignores the fact that there will be tax on the income that is earned as these payments are reinvested. What you want instead is to use an after-tax interest rate to do your discounting.

In this case, the after-tax interest rate is:
3% * ((1.0-(0.25+0.10))
=3% * 0.65
=1.95%

Our present value calculation now gives us:
=pv(0.0195/12,120,15000)
=$1,634,170.20

Why does our calculation give a higher present value?

Because, given the additional tax paid on the income that the spousal support earns when reinvested, a higher initial amount is needed to get the same end result.


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