Growing the Trust Fund: How much do you need today?
Posted June 8th, 2016.
Categories: The Calculating Lawyer.
So you want to stash away some money for your children — a trust fund. Or perhaps you need to fund a support trust for an elderly family member. If you want the fund to generate the same amount of money every year, year after year, then you need to consult the simple formula for the present value of a perpetuity.
But what if you wanted your trust fund to generate an increased amount of money every year. Perhaps you want it to increase by 2% every year (to cover the increasing costs of college tuition, living expenses, or health care costs, as the case may be).
What will it cost you in today’s dollars to generate, say, $100,000 per year, increasing by 2% each year, in perpetuity?
Assume the interest rate over time will be 3.5%.
The formula is: PV (Perpetuity) = P/i – g. That is, the present value (PV) of a growing perpetuity equals the payment (P) divided by the interest rate (i) minus the growth rate (g).
Here’s the math:
PV = P/i – g
PV = $100,000/.035 – .02
PV = $100,000 / – 0.15
PV = $6,666,666.67
So, in order to generate $100,000 per year, increasing by 2% each year, in perpetual trust funds, you will need to deposit $6,666,666.67 in the bank today. Provided that the interest rate of 3.5% remains intact, the account will generate the necessary funds each year.