That isn’t true or at least I don’t believe it is without some more concrete numbers. It may be true if you are MC Hammer but the math works fine if you have any sense. U.S. lotteries typically pay out over 20 years. It is dead simple to multiply your money over 20 years fairly safely and not that difficult to do it extremely safely. If you use the divide by 70 rule of thumb, you would need about a 5% - 6% annual return to double your money while accounting for spending at the same time. Granted, that is difficult to guarantee right now but it hasn’t been historically. A mix of bonds, stocks, and cash should easily be able to do that.
I am not calling you flat-out wrong however. You seem to have thought about this and know something about it. Where I think you are going wrong is that no winner is ever getting the full $100 million no matter how it is paid out because of taxes. You are taking that from the lump sum column and not doing it the same way for the yearly payouts. I admit I don’t understand why a large annuity wouldn’t be taxed the same way as the lump sum (and subject to future increases) when the amounts are large enough to hit the top tax rates every year for very large lottery payouts.
I would add that if you invest the lump sum yourself, you’re more than welcome to keep it invested longer than the 20 years the lottery commission would, increasing your total payout even more.
Last time I crunched the numbers, the annuity and the lump sum had the same Net Present Value at about a 6% interest rate. At the time, you could easily get that from a passbook savings account, so the lump sum was a better option. Today, the annuity might be better.
I think the current recession is temporary, so I do my daydreaming around a lump sum.
Time to break out the math on why the lump sum is at current interest and tax rates better than the annuity. Right, Powerball is paying out 62.6% of face value as the lump sum; Megamillions is paying out 72.5% of face value. Powerball pays out in 30 steadily increasing payments; Megamillions does 26 even payments. So I will compare Megamillions, since that part makes the math easier.
If the Megamillions face prize is $100 million, and the lump sum is $72.5 million, if you take the lump sum you will have $47.15 million left after the Federal goverment takes its taxes (I am assuming the winner lives in a state with no income tax to make things easier). The annuity winner would get $3.846 million before taxes, and $2.52 million a year, after Federal taxes. And that is assuming Federal taxes don’t go up in the near future, even though the top rates are relatively low right now. The lump sum winner can structure his winnings to pay capital gain/dividend taxes, which have been lower than the income tax rates for quite some time, or even invest in tax-free municipal bonds.
Anyways, if the lump sum winner can manage even 5.35% interest after taxes each year, he would have be getting slightly more money just in interest than the annuity winner gets in payments. Granted, 5.35% is hard to get in today’s markets without a fair amount of risks, but at a modest 3% interest (which can be done with a mix of rather low risk investments - there are tax-free muni bonds paying that much), he would make $1.414 million a year. If the annuity winner decided to live the same lifestyle, and invest $1.106 million a year (to have something when the annuity ran out), after the annuity runs out the annuity taker would have a $42.6 million nest egg; not quite as good as the person who took the lump sum. And having the money all at once gives you a lot more flexibility minimize one’s tax liability and invest over the long term.
I read somewhere that if you take the annuity payout for a lottery prize and die prior to receiving the last payment, your estate owes taxes on the total remaining amount. That can be a problem for your heirs, since they may not have that much cash available.
It’s not a large amount, but I’d be very happy to have an extra $50 a month for the next 10 years. $11.53-ish a week isn’t much, but hey, you could spend it on lottery tickets.
The Powerball lottery FAQ says that if someone getting an annuity dies, the estate has the option to cash out the rest of annuity to make it easier to divide up or pay taxes on. I do not know if that is the case for the Mega Millions lotto.
And in case anyone is wondering, annuitines from both lotteries keep paying out to the estate of the winner, if the winner dies.
The reason you hear more about lottery winners who waste it is that it makes a good story. “Guy wins $100 million dollar, blows it all on exciting things, is now broke and subject to bunches of lawsuits” makes a good news story, “Guy quietly pays off mortgages and takes pleasant but not overly extravagant vacations” doesn’t get the readers/viewers. Most stories that I’ve seen come up with something like vaguely half of lottery winners ending up worse off than before they won, which means that while there is no shortage of sob stories, there are also plenty of winners who do well.
Also the trick with lump sum vs annuity in the US is that you have to pay taxes on the lump sum before you invest it in anything, while the annuity invests the money pre-tax and you only pay tax as you get payments. Although it’s still possible that the lump sum payout is better, most people talking about investing the money forget that with lump sum you start with a smaller sum to invest than the annuity option does.
More like headology. The lump sum pay out is clearly stated up front for every drawing. You have the option to pick with all of the information given to you ahead of time. I wouldn’t call that bait and switch.
Beyond the math, both Powerball and Mega millions pay out over 30 years. I’m 51. Do I just sit back and hope I’m still around at 81 to get my last payment? No thanks.
For very large prizes (e.g. the recent $1.6B win), the tax is the pretty much the same whether you take the lump sum or the annuity. The highest US federal income tax bracket is 37%, and applies to amounts beyond $500,000 (single) or $600,000 (married filing jointly). So if you’re getting $80M/year for 20 years, you’re still going to be paying 37%, same as if you take the $800M one-time lump-sum.
Michigan’s state income tax is a straight percentage, so same deal. Not sure how it is in other states.
No, the tax is different even though the tax rate is the same. With the $800M lump sum, you owe 37% taxes right away, so you get $504 million after taxes and invest that smaller sum for your future payouts. With the Annuity, the fund takes that whole $800M and invests it, and you only pay the 37% taxes after it’s had 1-19 years to earn interest. You can still come out ahead because they use extremely safe investments that don’t pay that high of an interest rate, and because you can keep compounding differently than they do.
Sure, but the lump sum can be stolen from you in a variety of ways. Conning you, holding a gun to your head until you wire it over, hacking your accounts, etc. And you are a BIG target.
But altho certainly one payment of the annuity can be stolen that way, it would be REAL hard to do it 30 times.
And 81 is pretty likely today and wouldn’t you like to have some cash in the sunset years?
