Lottery annuity vs. lump sum

Cecil's Columns/Staff Reports
1

Not that the California lottery offers a lump sum option anymore, but in case anyone else’s state does, I offer herewith my own personal calculation of the relative benefits of taking the lump sum vs. the annuity:

Q = odds I will quit my job if I win
S = odds I will squander as much of the money as I get, as soon as I get it
Y = number of years I will be given money to squander
A = amount of money I will be given each year
R = remainder left over at the end of each year

The equation is thus:

(Q x (Y x A)) - (S x A) = R

If we assume my chance of quitting my job is 100%, or 1, then taking the lump sum, the calculation is as follows:

(1 x (1 x Lump Sum)) - (1 x Lump Sum) = 0

That is, if I quit my job, I get the entire lump sum and proceed to squander it.

Curiously, if I take the annual payments, my calculation for each year is quite similar:

(1 x (1 x Annual Payment)) - (1 x Annual Payment) = 0

So I’m still left with nothing at the end … of each of 26 years, rather than each of 1 year.

Therefore, I’m going with the annual payment scheme. Gives me that much less to squander annually and that much more to squander in each of the other 25 years!

Seriously, though, there’s ample evidence of people getting sudden windfalls and proceeding to go broke. The movie Lucky I believe profiled some, and so does this article. If you already know you’re a spendthrift (I am) and a sucker for a good cause (I am) then there’s every reason to expect you’ll blow through your lottery riches at breathtaking speed.

So if you’re like me … take the annuity.

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Hi Jenny - usually the board likes if you have a link to the article. Is this it? Link.

Common wisdom says that you should take the lump some and invest it.

My opinion is closer to yours. IMO, most people do not know how to manage that kind of money.
A yearly stipend would be better for most people.

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The Staff Report in question (brilliantly written, n’est-ce pas?) focused purely on the fianancial implications, and deliberately left aside the psychological factors, which aren’t quantifiable.

Anyhow, welcome, Jenny, and thanks for the comments. As Khadaji says, it’s helpful to other readers if you provide a link – saves searching time and keeps us on the same page. You’ll know for next time, we’re glad you found us!

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Ahem… It’s Genny. Let’s make our new guest feel welcome by getting his/her name right. :wink:

I’ve always figured that before I even turned in the ticket I’d have a meeting with a good tax attorney for professional advice and get all the appropriate accounts set up before collecting.

I’d probably be a squanderer, too, but I think I’d ultimately take the lump sum, pay myself a salary, and structure the whole thing to make it difficult to pull funds out ahead of the schedule I’d set, thus allowing the bulk of the winnings to continue to earn more. Or something like that. Like I said, I’d consult a pro.

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I think Genny might have forgotten one factor: How many more years can I expect to live and spend the money?

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Personally, I don’t trust the lottery commission to invest my money over 26 years, or find a way to weasel out of the contract before it’s all paid. I’d rather have a smaller amount up front to invest MYSELF.

Of course, the fact remains that most people who seriously play the lottery are people who don’t know how to manage money in the first place. I only buy a ticket when I have an extra dollar in my wallet I don’t mind losing, and never for a $12M payoff (which after taxes and lump sum deductions, would be closer to $3M).

I used to work with a guy who spent $100 a WEEK on lottery tickets. He told me that at least once a month, he’d get a $150 payout, and thought he was MAKING money that way (you’d have to hit the $150 payout at least 3 times a month to profit).

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That sounds like the people sitting around in one of my regular hangouts totally hexed by various machines separating them from their money. From time to time they venture out in the bar to collect their rewards and one of them has told me that he actually makes a profit, which I find extremely hard to believe.

All in all, a sad bunch.

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I used to know a guy who received annuity payments (it was a trust fund not a lottery but it worked pretty much the same). Every three months, he’d get a check for around $2500. And then he’d disappear for a few days. As soon as he cashed the check he’d go out and start buying all the drugs he could. He’d apparently do anything so he’d end taking whatever he happened to get his hands on first. He’d burn through all his money in a day or so, get massively stoned, bottom out, drag himself home, and go back to being a normally broke college student for another three months.

Those of us who knew him all agreed that the worst thing that could happen would be for him to get his hands on a big lump sum of money. If he did, he kill himself. So in his case, the annuity was definitely the way to go.