Tom Brady is an all-time great quarterback. Maybe the best ever. His career earnings over 23 years are about $330,000,000. He will likely retire at the end of next season and take on a new career. An in-game commentator for Fox football broadcasts.
Instead of being pounded by athletic 275-pound defensive linemen, he will be able to wear a sports jacket and use his knowledge to entertain us. For this, he will be paid $37,500,000 per year for ten years. More money in less time.
What is that contract worth as a lump sum now?
Net present value is the single sum equal to the value of a series of future cash flows. We know money in your hand today is worth more than money to be received in the future. You could have invested, and the money a year from now would be more by whatever you estimate you could invest in.
For 10 payments, you would need to calculate how much each one is worth today by taking the cash flow you know for each year and “discounting” it by what you could earn. A tedious bit of work with a pencil. Trivial with a spreadsheet.
The important ones are how much tax will be excised before he can use the money, how much does he pay for lawyers and agents, his discount rate for return on investment, and when does the money appear?
We know he lives in Florida, and they don’t have a state income tax, so he will pay the top federal rate of 37%.
Let’s further guess his helper fees are 5% of income or about 3% after tax deductions.
He will keep 60%, or about $22,500,000 a year.
I will assume they pay him once a year in advance because that’s easier than breaking it down into monthly chunks. Monthly would create 12 times more calculations, and if you are using a pencil, that matters. Spreadsheets don’t care.
What is left is the discount rate. The least yield Tom would accept for investments. Let’s assume 5% after taxes.
Using those factors, we calculate, well excel does, the single lump sum today equivalent to that contract is $173,739,035.91.
If he needed just 3%, it’s worth about $192,000,000. When the discount rate is lower, those payments in the future are worth more. If he wants 10%, the contract is worth about $138,000,000. A high discount rate makes distant payments worth much less. At 10% a payment 9 years and one day away, the first day of the tenth year of the contract is worth not $22,500,000 but $9,542,196. The amount he could invest today at 10% and have $22,500,000 9 years later.
Part of financial management is the answer to the where question. Florida has no state income tax. California would charge him 13.3%. That’s $5,000,000 a year. We won’t see Tom move to California. There are several states where the state tax exceeds 10% on income at that level. New York, New Jersey, Hawaii, and DC are among them.
Many high-income people move from the high tax states to Florida, Texas, Tennessee, Wyoming, Nevada, Alaska, Washington taxes capital gains only, and South Dakota. I wonder what the high tax, high spend states will do about that?
The contract’s present value bumps Tom’s net worth to over $420 million. About the equal of his wife’s net worth. I doubt there will be a Go-Fund-Me campaign for them.
I wonder how U-Haul manages to have any trucks in California. I’ll bet there is a surplus in Texas and the other low-rate states.
A dollar in hand is worth more than a dollar to be received later. How much more is just arithmetic. Sometimes you can negotiate a better deal when your discount rate is different than the one the person you negotiate with is using for their side of the calculation.
Taxes matter. Where you are resident is an economic thing anymore. Athletes particularly are likely to live in low-tax states because their careers are short. When they, or you, needlessly give up taxes, it is never recovered.
How much is your career worth when you think about net present value? It is almost certainly your most valuable asset. Nurture it.
Learn to notice what the numbers mean instead of what they are.
I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email at firstname.lastname@example.org.