Sorry to jump on the lottery-thread bandwagon, but…
Is there a meaningful financial difference between a winner taking a giant lump sum and then using a large portion of it to buy an annuity that will last the rest of their life, as opposed to taking the 29 installments of X million dollars a year?
In both cases, they want a steady income of several million dollars a year. And in both cases, they’d be paying lots of taxes every year.
Second question: out of sheer curiosity, what’s the largest annuity that’s ever been offered or sold? Could Jeff Bezos buy a $75 billion annuity if he wanted? (Disregarding the whys he would ever want to do so)
(a) The baseline risk-free interest rate market, which is well defined and liquid for any practical amount.
(b) The creditworthiness of the provider. The appropriate credit spread over the baseline interest rate, a major consideration over many decades. It might be unwise to put all your eggs in one basket for your entire net worth, even if that basket is a U.S. State.
Other considerations with a government lottery: the provider may feel that it’s worth taking concentrated actuarial risk in order to match payout timing to future tax revenues; and people who get a huge windfall may be price-insensitive and psychologically prefer the lump sum. So they may price the lump sum much lower than the theoretical value of the annuity.
As I recall, the Net Present Value of the lump sum, and the Net Present Value of the annuity, are equal when the interest rate is about 6%.
When I was young, you could get better than 6% from an ordinary passbook savings account, which made the lump sum a better deal.
Since the financial crisis of 2008, the Federal Reserve has been suppressing interest rates, which makes the annuity a better deal. (Assuming, of course, that the company handling the annuity doesn’t go bankrupt in the next 20 years.)
Recently, there has been talk of the Fed raising rates. Anyone know how far, and how soon?
I’ve long wondered why people are psychologically drawn towards the lump sum. Maybe I’m overly risk-averse, but the idea of getting my money all at once scares me, because it means I could lose it all at once.
Typically, you are financially better off taking the lump sum, as the discount rate to calculate the lump sum is so low, that if you think you can earn better than 2% investing the lump sum, then you should take it and invest it so that you are earning more than the implied discount rate.
I would take the annuity and still invest on top of that. If I’m getting 30-35 million a year after taxes (very rough estimate with rounding), I’ll have more than enough to live off of. Even if I live off of 2-3 million a year (a big upgrade for my life), I can donate a couple million each year and still easily invest 20 million plus each year. (Ok, maybe the first year, I spend a little more building a new house and doing the travelling I always wanted to do, but after that… 2 million a year.) Sure, I’m starting the investing more gradually than if I had a lump sum, but eventually that money will get rolled into the investment, too.
I’m still not clear on how to compute it, but there are online annuity calculators. Trying several, it looks like investing $900 million to return 26 annual annuity payments of $60 (= $1600 / 26) requires investments earning about 5%.
It also looks like if you die, the payouts continue to your estate. I’m not seeing a strong reason to take the lump sum.
Yep. Can’t deposit in a bank and expect FDIC to look after you - the limit there is a few hundred thousand at best.
Any other investment doesn’t even have that much of a guarantee.
A state could in theory go bankrupt, though I have not heard of any doing so and I don’t know if unpaid lottery winnings would be at risk if it happened.
With a private annuity, what happens if you die after a year or two? I assume (unless the policy is wrtten differently) the company would keep the difference. I think (but might be wrong) that if you elect the annual payment option then die, the remaining payments would be made to your heirs.
If you’re going to spend it all on hookers and blow (vs investing in something income-producing) it might be better to take it all now. Max tax rate is, say, 35% and you get 100 million now vs 200 million over 30 years. You’d pay 35 million this year, vs a total of 70 million over the 30 years. Of course to make this work, you’d need to either ration your hookers&blow funds to make them last - or spend them all at once and die a glorious sudden death.
My personal preference (and I will need to implement this Saturday when we win Powerball): take the annual payments, and put half of each year’s money aside into something secured.