Basically, you can take a full payout over 30 years or take about 50% immediately. By the rule of 72, if you can get more than 2.4% interest you would get more money by taking the money now and investing it. I know that tax-wise it may make a difference between $60million in one year vs $2million each year x 30 but would theat make enough of a difference? OK maybe now I need to make 3% on my money. But looking it as an annuity, $1 million (after taxes and spending) invested at 3% per annum builds to to $47million but at 3% the lumpsum grows to over $70million over the same time.
So is there any reason to take the annuity over the lumpsum? P.S. not married so community property is not in play.
But if yourself isn’t stupid, taking the lump sum is probably better.
When the lottery people say “the jackpot is $10 million” what they’re really saying is “the jackpot is however much a $10 million 30-year annuity is.” You can take the annuity or you can take however much the annuity costs – either way it costs the lottery people the same thing.
So the question is, can you make more money on the lump sum over 30 years than the annuity would get you? The answer is almost assuredly yes, and you don’t even have to be a super-shrewd Gordon Gecko type to pull it off. Stick it all in a basket of moderate and safe index funds, for example, and over 30 years you will definitely achieve a higher rate of return than the annuity would provide.
A lot of people who win lump sums get in trouble because they have NO IDEA how to manage the money and how to live with it. They act exactly like 19 year old kids who win the sports draft lottery. In other words, they act like this is the first installment in a never ending flow of cash rather than a one-time “invest like you’ll never see another dime in your life” payment.
Let’s use two examples;
Scenario A(nnuity)
You win the $20 million Powerball and take the annuity option. You get $20 million paid in 30 annual payments, or $666,667 per year. The first year you get that check, which works out to be about $400,000 after taxes (depending on where you live).
Ok, so what can you do with $400k? Well, obviously you can’t go nuts. You can buy a new car, pay off some bills, and buy a decent suburban house or urban condo in most places. You can take a vacation or two. You can buy some small gifts for others. And if you don’t watch it, you can rack up some bills to be paid next year.
Each year after that, you get another $400k after taxes, and you slowly build up your estate while not being all that tempted with the “I got money to piss away!” mentality.
Scenario B(ingo!)
You win the $20 million. You take the annuity, which varies, but we’ll say in this instance it is $9.6 million. You end up with about $5.8 million, plus or minus, after taxes.
Holy shit! I have serious cash! I can buy that Ferrari, the $1 million dollar mansion, the lake home, the house in Florida…I can buy my relatives cars and houses, I can burn $100 bills to heat my house, blah blah blah, because I GOT OVER FIVE MILLION DOLLARS BABY!
Then within a couple of years, it has all been pissed away, and you start selling things off to downsize your life. Or you refuse to do so until you’ve ‘maintained your extravagant lifestyle’ to the point where you owe as much as your shit is worth, and you’re right back to where you started.
The temptation is very high.
The difference is how wise you are in recognizing the limits of your own behavior. If you can take the $5.8 mill and keep your ambitions in check so as to invest at least $4 million of that while fending off vampiric friends, family and total strangers, then go for it. But if you immediately start thinking about how much you can spend and how fast, then you’re fucked with the cash option.
What the average person doesn’t realize is that money will alleviate a whole set of problems but it will introduce a whole new set of problems that the individual has never previously faced. There are things like tax considerations, estate planning, family trusts, advisers, insurance, philanthropy, wills, envy, greed, and a host of other things that never had to be dealt with before. Some people cave under the bewilderment and subconsciously decide that they were more comfortable in dealing with the problems they were familiar with. Therefore, they blow the cash to get back to where they were.
Even if you take the annuity there are slime-buckets out there that will pursue you. They will offer to buy the annuity off you for a lump sum that is a worse deal than if you had taken the lump sum in the first place. At the first sign of a financial squeeze some people will bite at the offer and really screw themselves.
Being disciplined with money is a talent. A lot of people just don’t have that talent. Therefore, no amount of money will ever make them happy of solve their problems.
I don`t see why taxes could make a difference for you, let alone a meaningful difference. It’s not like someone making $2,000,000 / year in lottery earnings is going to be in a lower tax bracket than someone making $60,000,000. And either way it’s cash winnings so it’s not like you have a large taxable event without a cash event to make paying possible. So it’s not taxes.
All that’s left is what you said - figure out what rate the annuity is earning and decide if you can earn a higher after-expenses. Remember your expenses will be higher than you might otherwise expect. If you have a few hundred thousand in your retirement account, you may have it in an index fund that nominally earned 5% last year but only earned 4.7% after the mutual fund’s fees. With $60,000,000 you’ll need to hire money managers and a CPA firm to keep them in line and probably lawyers. As a % it ought to be low but you can’t simply compare what the annuity earns to what you expect you can earn. You have to say, how much can I earn after taking into account the cost of investing the annuity payment vs. how much can I earn after taking into account the costs of investing the much larger lump sum?
The annuity, I believe, is also quite low risk - they’re legally obliged to pay you. If you think, even after all your expenses, you could earn 2 points more on average than the annuity will pay out, the lump sum would be better. But how sure are you of your expectation? What if you earn less than the annuity on average? What if you lose money some years?
I could be wrong but I was told an annuity is not part of your estate.
So (if true) you win $100 million and take the annuity option and die the following day your estate only collected the first payment. The state keeps the rest.
Personally I say take the lump sum regardless of this unless you know you are a disaster with managing your money. I’d much rather have the money in my bank account to do as I choose than letting the state hang on to it. If you have to put your money in a Trust that pays you out like the state would but at least your money is earning you money while doing that.
That said I have read numerous stories of people whose lives were ruined by winning the lottery. People who literally went bankrupt after winning millions.
“A lottery annuity prize is just like any other asset. You can pass any remaining annuity payments on to your heirs or to anyone else. The Powerball game will even cash out an annuity prize for an estate. This may make it easier for the estate to distribute the…”
Actually, for 400k I’ll keep my old car (and truck - I like my truck) and maybe buy the building I live in. It needs about 30-40k in work to really spiff it up, but what the hell - I’ll put a new roof on, rehab the largest apartment in the place to live in, then use my current apartment as a studio/workroom/storage for my many hobbies and projects. I’ll let my current landlord keep his shop next door rent free as a thank you for all the years he’s helped me and mine out, and because he’s a friend. That leaves two more apartments upstairs - maybe I’ll make them guest rooms. Or rent them to little old ladies of quiet habits. Provide housing for destitute friends. Don’t know. Anyhow - I’ll have a comfortable place to live with more than adequate space, owned free and clear that I can use for rental income if I really want.
That would leave me… what? Still hundreds of thousands the first year. Yep, visit friends and family without having to worry about needing a job. Travel a bit, but I’m a really cheap traveler even when I have money.
Hey, I can get back to flying airplanes! Blow ten thousand or so on that, easy, getting back up to speed, but really I should have $200,000 left over to invest.
The next year I buy an airplane - the sort I want can be had for $200k, so that would leave me ample to live on.
I’d go back to college and study whatever I want. Because, hey, I don’t have to worry about a job, right?
And I invest whatever I don’t spend.
Year three - probably I need to look into retraining for a new profession. I’m not the sort to sit on my butt and do nothing forever. But finances no longer limit my training opportunities. Hell, if I wanted to go to medical school I could afford to pay cash up front, right? (Rather doubt I’d want to go to medical school, though, it’s just an example).
And I invest whatever I don’t spend that year.
Of course, this really only works if your a person such as myself who, aside from aviation, doesn’t have particuarly extravagant wants. And even there, my wants in aviation are nowhere near the most expensive.
I guess my point is that I would take the annuity, but plan to invest some of every year’s annunity income because, you know, eventually that annuity runs out, right? And I plan to live longer than another 30 years.
It also has the advantage that even if I totally screw up my investing choices one year it will limit the damages. Because I’m honest enough to admit I’m not an investment expert and I will make mistakes.
And the fact that someone wins the lottery is a major strike against them. If you had to come up with a single criterion on which to judge how much financial discipline an otherwise unknown person has, “Do they buy lottery tickets?” would probably be pretty high on the list.
A former co-worker of mine called it “The Idiot Tax”.
I admit, I pay mine. I don’t see any issues with spending a whole whopping dollar on a lottery ticket. I don’t go nuts, I’m not like those old people I see who spend 20 minutes purchasing $100 of scratch off tickets every day or so. But if I spend $5 a week on lottery tickets (or less), it’s a small bit of entertainment and it is ultimately less damaging to my wallet and my health than all the people around me who are spending $30 a week or more on cigarettes. Cheaper than a single beer at a bar, cheaper than a fast food meal. Big whoop.
In previous threads on this topic, it was pointed out that the state invests the money in absurdly low-risk portfolios. I believe that’s by law in many states. The difference in payouts between lump sum and annuity is calculated based on this low rate of return.
Because they must invest it this way, and have very little flexibility in how they can invest, you can certainly make more return on your own. The difference between the two is the “profit” you can get by taking the lump sum.
Disregarding all the other social and psychological factors, from a purely financial standpoint, the correct decision is taking the lump sum.
That argument only works if the potential investor is both educated and dispassionate about the money. That is seldom the case n real life.
Again, the problem is that in real life you never get away from the social and psychological factors.
It’s rather like how the average driver sincerely believes he is an above average driver, which is statistical nonsense.
Despite the logic of investing a lump sum, in practice that doesn’t always happen. Perhaps it seldom happens. There are instances were psychological factors should not be dismissed but rather given significant weight.
Why not just take the lump sum, and create a trust that pays yourself an annuity. You can turn the trust over to a professional investment advisor, that is sure to earn a much better return than the state. This way your annuity should last longer than the 30 years.
I don’t know about anywhere else, but in New York State, they don’t actually buy an annuity. They pay you out of current income. In other words, your annual payments can disappear with a stroke of the governor’s pen.
Just because someone is a “professional investment adviser” doesn’t mean I’ll trust him. I mean, look at Bernie Madoff. I understand he’s exceptional, but these things happen. The doesn’t mean lump-sum+investment adviser is a wrong decision, just that it’s one of several options.
If you went with what I proposed - investing half of the annuity every year - you’d still have investments and income after the lottery annuity ends.
While it may not be the option that gathers the most money in the end, getting rich as possible as fast as possible isn’t always a person’s end goal. Me, I would, in many ways, prefer a steady income over a sudden one-time burst of funds. It’s those messy psychological factors at work again.
One thing’s for sure - if ever I did win such a sum the FIRST person I’d go to would be tax lawyer type of adviser, someone who could crunch the numbers for me and lay out my alternatives with both the positives and negative of each course of action
The OP was clearly looking for a financial argument. I’m sure he also knew that we are not dispassionate robots. That is why I specifically mentioned my post only addressed the financial part. Sure, we should all go read Nudge and Predictably Irrational and only invest in index funds, etc.
Generally speaking, there is one huge advantage to accepting the annuity rather than cash payout. Let’s pretend that the lottery has 100 Million on cash for the prize. They would typically list the annuity as around 200 or so.
What they are doing is investing the money and then paying to you the interest and a portion of the principal so that by the end of the annuity period the balance is 0 - meaning that as time goes on more and more of the payout is made up of principal rather than interest - kind of like a mortgage (but being paid to you rather than you paying out).
You could, of course, take the money and do the same thing yourself. BUT - when you receive the cash payout, you will be taxed on the lump sum - so you’ll pay around 40-50%, depending on what state you are in. Let’s say you pay 45% for sake of argument. That will leave you with 55 Million Dollars to invest. Any interest that you receive will be taxed at the capital gains rate, which will probably be around 15%. I’ll assume that you’re smart enough to relocate to a state with no capital gains tax. So, let’s pretend you earn 7% interest - a pretty good rate. With that rate of return, you would earn approximately 3.85 million dollars in interest the first year, which, after tax, would be about 3.27 million dollars. You can also ‘take’ some of the principla - as you can let the principal decline over time and still have a fixed total income as you draw more and more principal and less and less interest over time as the principal declines to zero. But let’s ignore the principal portion for a moment and look at what the lottery does.
The lottery will invest your PRE-TAX money and make payments to you out of the interest and principal. These payments will most likely be annual and will all be taxed as ordinary income - again, let’s assume 45%. In order to pay you 200 Million dollars over a 25 year period (the lotto ‘ads’ usually indicate that the annuity is about double the cash payout), they would need to pay you 25 payments of 8 million dollars. A little tells you that in order to do this and have the principal decline to 0 at the end would require an interest rate of about 6.1%. In terms of take-home cash, you have 55% of the 8 million after taxes, which equals about 4.4 Million dollars.
OK, so you get 4.4 million with the annuity after taxes, whereas you get 3.27 million after taxes from the interest in the first year from the cash payout. That means you would need to be able to take 0.66 million out of principal in order to match the annuity. Of course, you will need to take more principal out each year because your interest will decline as it is gnerated from a lower principal base. So when do you run out of principal by trying to keep up with the annuity schedule? Well, as it goes you end up coming up 1.9 Million short of being able to get 4.4 million after tax in year 25. So, for all practical purposes, you get exactly the same amount of money.
BUT. You have to invest in 7% portfolio to get this to work, which means you have a little risk - these aren’t T-Bonds. AND, you are assuming a 15% capital gains rate and I don’t know that I would want to bet it stays there for 25 years. If it rises to 25%, you need to push your return up 8% to keep up. Of course, you face ordinary income tax risk on the other end - but 45% is somewhat high (it can go higher of course, but I feel the risk of increase of the capital gains is a little higher). Ultimately, I think the annuity is less risky because you don’t add the market risk on top of the tax risk. All of this is ignoring any kind of moral hazard you might want to consider.
I’m sorry, but I would trust your average run of the mill Investment Manager at Smith Barney or Morgan Stanley over any state Treasurer, with my money any day of the week.
I don’t see any issues with spending a whole whopping dollar on a lottery ticket. I don’t go nuts, I’m not like those old people I see who spend 20 minutes purchasing $100 of scratch off tickets every day or so. But if I spend $5 a week on lottery tickets (or less), it’s a small bit of entertainment and it is ultimately less damaging to my wallet and my health than all the people around me who are spending $30 a week or more on cigarettes. Cheaper than a single beer at a bar, cheaper than a fast food meal. Big whoop.