Which option is preferrable if I hit the $120 million Powerball?
If you forget about taxes, you want the lump sum. Then you can put it all in the bank and earn interest on it. (Assuming you weren’t planning on spending it all on cocaine, mansions, and an entourage, that is.)
If you include taxes, then it’s more complicated. If it’s a really huge prize like $120 mill, you probably still want the lump sum, since most of the money will probably be taxed at the maximum rate no matter how you take it.
A piddling little $1 million prize, though, you might want to spread out over the years so you can keep yourself out of the maximum tax bracket.
Disclaimer: I am not an accountant, tax laws vary from state to state and country to country, taxes titles and destination fees not included, yadda yadda.
How long is your annuity? How much payable per year?
Boy, if you won $150M you would surely get assistance on this from your state & youll surely be able to hire an accountant if the state doesn’t give you one.
The payments are spread out over 25 years. It’s the same amount each year, I assume.
I have to admidt, I’ve always wondered about this too. What really interests me are the people that win the big one, but hire an accountant, or someone in the know, and wait a few days before coming forward to collect the jackpot. I wondered and looked around, but I’ve never seen what they were up to in the interim period. That is, were they busy setting up bank accounts, deciding who would actually redeem the prize, what?
I’ve always wanted to know.
This page says the cash option for the $120 million drawing will be $66.6 million. I can’t seem to do the math, but that should be enough to figure out what percentage rate they’re assuming for the annuity. Then you just decide whether you think you can beat it. If so, take the cash, otherwise take the annuity.
Take the lump sum. SmackFu is right–it’s a relatively simple matter to find out what rate you’d have to beat, though I’m not going to do it at this hour. In any case, I’ve always presumed that the states count on you to be ignorant of the idea of net present value, and say “There’s no way I’m taking $66.6 million when I could get $120 million–give me the annuity.”
If its an annuity due (i.e., payment received at the beginning of each of those 25 years), then I make the interest rate out to be 2.38%. If you were to take the cash option and invest it all without worrying about taxes, then it looks like you could easily beat that interest rate and come out ahead of the game. But maybe that scenario doesn’t fit your needs.
I’m pretty sure the answer is not 2.38%. That’s what I calculated, but I decided it was too low. If that was the rate, everyone would take the cash.
The problem is that the money isn’t just left in a bank account to grow over the years. $4.8 million has to be paid out each year, and it stops earning after it’s paid out.
I assume you used a simple complex interest formula like I did. That assumes that the amount after 1 year will be $66.6 mil + 2.38% of $66.6 mil, which is $68.2 mil. But that’s not correct. After the first year, the principal would only be $66.6 mil + investment income - $4.8 mil (1/25 of $120 mil), which is quite a bit less. So the rate of return on the investment needs to be quite a bit higher than 2.38% for it to work out.
Anyways, I think the right percentage is 5.157%.
In theory, you can calculate it using the formulas on this page. But I couldn’t figure out how to solve for the rate, so I had to do it with a program making guesses. Sometimes I wish I hadn’t sold all those college textbooks back.
Even if you could beat 5.157% the interest would still probably be taxable. That’s where the CPA formulas come in.
Considering the bracket you’re about to be rocketed into you would probably do well in investment grade municipals.
If you’re in a high tax state like California or Massachusetts you’d probably be guided toward a trust with municipals within your state.
It seems to take the CPA’s a couple of days to run the numbers in each example I’ve seen in the newspapers.
In any case you’ll probably not just put the money in the bank and earn interest on it. Some states give you a window of time to set up a trust.
This may sound stupid, or everyone else is well aware of it, but are people taking basic taxes into all this?
That is, the $66 million is the pre-tax, lump, payment. And, obviously, the $120 million is too.
When you look at it as getting, what?, about $44 million, right? versus $120 million spread out (And still taxed to the max) over twenty five years.
For some reason, I always believed the annuity was the smart choice, in terms of the overall payment.
I’m sure I’m missing something obvious here, but why do you have to subtract the $4.8 million from the principal each year? I thought a lump sum was a lump sum, and the question of 25 years or $120 million simply didn’t enter the picture when you are considering how to invest that lump sum.
The question (excluding the issue of taxes, which is now even more complicated because of the substantial federal tax changes which aren’t fully effective until 2010, and there’s the question of what happens after that date) is "how much is a stream of income of $4.8 million annually for 25 years worth right now." If your answer is higher than $66.6 million, take the annuity; if it is less, take the lump sum.
I believe the discount rate is 5.72557%, arrived at in this fashion. The $4.8 million you receive this year is worth $4.8 million. The $4.8 million you receive next year is worth less, due to inflation. The $4.8 million you receive the year after is worth even less, and so on. Assuming a discount rate of 3%, the $4.8 million in the second year is worth $4,660,194 today; the payment in the second year is worth $4,524,460 today, etc.
Setting up your simple spreadsheet (although there are functions for this; I like to do it myself because it’s easier to check the results), column A has 0 (this period) to 24; column B has $4.8 million in every cell; column C has Bx/(1+r)^Ax (x’s being row numbers, r being the discount rate). It’s then a simple matter to solve for r to make the sum of column B equal to $66.6 million.
A rate of 5.72557% makes that stream of income equal to $66.6 million. This is easy to check–periodic investments of $4.8 million for 25 years at a return of that amount equal the $66.6 million invested at that amount for 25 years–$253,393,530.
I’m trying to recall whether that’s the real rate or not; I believe it is. So if you add an assumed rate of inflation (say, 2.5%), you’d need to beat 8.23%. Over 25 years, I’d take the chance.
Of course, taxes are a whole other issue. If I’m bored this afternoon, I may tackle that.
There’s one important consideration for many lottery payouts – namely, that the only person who can collect is the person who won. In other words, if you elect to receive the annuity and then croak the next year, your spouse (or kids or whatever) doesn’t get any more money.
I used to be in the annuity boat. Now I’ve changed my mind – give me the cash up front, and I’ll gladly pay the taxes and live off the interest.
Not that this will ever happen to me.
If you are on the old side BingoBurringo, you’d take all the money. If you are younger, the yearly thing is better probably.
I forgot how they do it but I think that they just buy a zero coupon bond for 25 years (In Calif, its 26 years). That would cost the state about half the amount, perhaps a little less. I haven’t done the math.
I asked this about the California lottery in the thread http://boards.straightdope.com/sdmb/showthread.php?threadid=60062
Basically, it boils down to whether you want the lottery to invest your winnings at a conservative rate (3-4%) and pay them out yearly, or if you want to try it yourself and take the hit on taxes. The estate issue isn’t relevant in California, as there the winnings are considered part of the estate of the winner and would continue to be paid out in case of his (assuredly accidental) death.
Not in CA, anyway. From their website;
Makes sense, if you think about it.
Peace,
mangeorge
Now I might be the one wrong here but I always assumed the $66 million was the POST tax amount. That is, you actually get to put $66 million into your bank. The $54 million you lose is the government taking their cut up front (their taxes and any interest they might have planned on getting if they hung on to your money for 25 years) and you’re done with it (you will have to pay taxes on any future interest you earn).
If that’s not the case what is the state taking the $54 million for?
What always gets me is if you won that money and decided to spread the love around to family and friends they have to also pay taxes on it (it’s income for them). Essentially the same money gets taxed twice in the same year…once when you get it and once when your (say) brother gets his share. Doesn’t seem fair somehow but then again it’s hard to complain after winning $66 million!
Nope.
According to the Powerball site, if you take cash you only get half of the estimated jackpot.
From that site-
So, you’re talking about $66 million pre-tax if you take the lump sum. Or, if you choose the annuity, you get $120 million pre-tax spread out over twenty-five years.
And, yeah, I agree, the way the state and goverment comes after your winnings is pretty offensive. They get you every which way and more.
I still think you’re better off taking the annuity.
It’s still a problem I wouldn’t mind having, though.
No. This gets at my earlier posts. There is no difference between the $120 million over 25 years and the $66.6 million now. The $66.6 million now is the states’ estimation of what the payment stream of $4.8 million over 25 years is worth right now–the net present value of that income stream. That’s all that difference is–it has nothing to do with taxes, fees or anything else.
And the point is, they aren’t “taking” the $54 million–either way you take the payout, it’s only worth $66.6 million.