An earlier thread was discussing lottery winnings and this link was referenced, which compares the powerball payout as a lump sum payout vs the 30 year annuities option. Looking at the numbers, the first reaction is that by taking the lump sum, a lottery winner is screwing themselves out of approximately $40 million dollars. But are they?
A friend insists that taking the lump sum is the much better deal for a few reasons. For this we’ll be using the Virginia figures, since that’s where we live. The lump sum payout, after federal and state taxes is just shy of $65 million, received in 2012. Compare this to an annuity of about $3.5 million per year for 30 years, totaling $103.5 million in 2042. First off, my friend says money today is worth more than money tomorrow. By 2042, inflation and the cost of living and such will decrease the final real worth of the winnings, making the lump sum payment that much more valuable. Further, investing the $65 million and using the magic of compound interest will certainly make the lump sum payment worth more, in 2042 dollars, then the annuities option.
I get the argument, but that seems like an awful lot of ground to make up. However, I’m not sure how to calculate the power of the two payment options, in order to take into account inflation and a reasonable expectation of return on that kind of wealth.
What say you dopers? Which is the better deal and more importantly, why?
Compound interest has nothing to do with it; compound inflation everything.
Let’s say you invest your $65M in the stock market. You get about 3% dividend from your stocks for a gross income of about $2M. In America you pay about 15% tax on dividends, if I’ve read previous threads correctly, for a net return of $1.7M, or half the annuity. That doesn’t sound so good. But assume 5% inflation and nil net real growth. After 30 years inflation means that your income is now over $7M (that’s the equivalent of $1.7M today). And you still have the $65M (which is now over $280M), and you still get income in years to follow. Whereas with the annuity, you get $3.5M per year for 30 years, but in 2042, that $3.5M will be the equivalent of about $800K today. And then you stop getting it.
Of course, you could invest the $65M badly and lose the lot.
Without looking at the requirements of a particular lottery, it’s hard to answer. Are annual payments under an annuity equal? Or are they on a sliding scale, starting very small and ending with a massive balloon payment in the last year of the annuity? And once your get into the several million dollar winner category, what’s the big deal? How many lottery winners have the money management acumen to make a permanent better life for themselves?
FWIW, I’ll take the lump sum. It will last me my lifetime and beyond. Besides, in this economy I prefer having the cash in hand and I will invest my money as I see fit.
I always thought it would be fun to take lump sum and put it into a non interest bearing account. Rationale: The government taxes you on it when you get it. Then they will tax any interest that it earns every year. They can not tax you on an income that does not exist. No interest, no income. You then do not pay an income tax to anybody ever again, however you do pay the taxes on property so you are best not buying the expensive toys - ultra sports cars, big boats, huge houses. So if you stay with sensible cars, moderate toys, moderate house and maybe a vacation property you can basically screw the government out of money. [I would also take a certain amount in cash and stash it in a well hidden safe in the house and not let anybody know that it is there.]
Realistically, I would probably go for the annuity, and still live moderately. As fun as it would be to have a stable of sports cars, I would be happy with a brand new jetta and perhaps a Jensen FF for fun. I might buy that missile silo in the Adirondaks that has been for sale for the past few years - though I am not sure what I would do with the runway and airplane hangar, maybe learn to fly?
I’d take the lump and invest it and use it even if economically suboptimal in the long run. No one can predict 10 or 20 years into the future.
Of course, if you know yourself and know you couldn’t stop yourself form buying 100 Ferrairs 458, then take the annuity
Weren’t there companies who would get you ticket for a larger lump sum than offered by the lottery itslef? I remember reading/watching some ad 15 years ago.
This biggest argument for taking the annuity is the difference between the principal the state has to invest on your behalf, and what you have to invest on your own, due to taxes. You have $65 million, but the state has $100 million, because they do not have to pay any taxes before they invest the money. Smaller principal equals much smaller capital gains over the twenty years of the annuity. The state probably invests in less risky financial instruments than individuals, which may work in your favor if you take the lump sum. But if you had invested in the stock market before the recession of 2008-2009, you would have lost a large chunk of your principal, so risk is a big factor in who would make more.
Actually, if you have a year to claim your prize, is it worth trying to fast-track getting citizenship in another country with lower (or no) taxes on winnings? How long would it take for an American to get Canadian citizenship, and would it matter if he was a U.S. citizen at the time of the draw (as opposed to at the time of the claim)?
Assuming Canadian citizenship can’t be arranged quickly, are there suitable alternatives? Can one get a Somali passport, for example, for a relatively minuscule “processing fee”, i.e. bribe?
Actually, you’d be giving the government more money. You are paying the highest marginal rate on your winnings - X, where X is where the highest rate cuts in. If you take the annuity, you are paying the below the highest rate on Y * X, where Y is the number of years in the annuity.
And of course you only pay taxes on what you make from investing your winnings.If you feel that negative about taxes, you should quit your job and become homeless. That will show Uncle Sam!
The answer depends strongly on whether you think you can get more from safe investments than the annuity pays you. I’d guess you probably could. However, there is another factor. While you can invest almost all of the lump sum, unless you plan to fully spend the annuity every year, you can invest part of that to support you when the annuity runs out. How well you do depends on how much you expect to spend every year.
One thing no one has mentioned is the age of the recipient. Much as I hate to admit it, I’m getting to an age where it is no longer a relatively sure thing I’d last out the duration of an annuitized settlement.
For my circumstances, I’d take the lump sum every time. I would probably annuitize some or most of that, but most likely on a different schedule than offered by the State.
Well, actually there are nuances to it (for Canadians, at least) which would allow a refund of the withheld tax, if, it seems, you were not a resident of the U.S. at the time, which would rule out my proposed scenario but covers situations where a vacationing Canadian buys a winning lottery ticket in the U.S.