What is Time Value of Money?
The time value of money is the idea that a dollar today is worth more than a dollar in the future, because money you hold now can be invested and earn interest. It is the single most important concept in annuity math.
How the Time Value of Money Works
Two tools put the idea into numbers. Present value moves a future amount back to what it is worth today, and future value projects today’s money forward with compounding. Both use a discount rate to do the math.
For example, $1,000 today invested at 5% becomes about $1,629 in 10 years. Run it the other way, and $1,629 promised in 10 years is worth only $1,000 today. It is the same relationship viewed from opposite ends.
Why It Matters When You Buy an Annuity
Every annuity decision is a time-value-of-money decision. Whether to take a lump sum or income, how a single premium immediate annuity is priced, and even why a lottery cash option is smaller than the jackpot all come back to this one principle.
