One other factor to consider that wasn’t mentioned was taxes and tax brackets
They create an additional factor that is non trivial for prizes under 8 million or so.
For example if you are single and win 3 million dollars that pays out over 25 years ($120,000) or 1,500,000 right away you will probably be in the 28% rate for
the annual payments or the 35% bracket for the 1.5 million all at once.
( provided http://taxes.yahoo.com/rates.html is correct)
Your investements will need to work a bit harder to overcome that initial hit-
If you win 8 million or more then both the annual and the at once payments are placing you in the highest bracket so it does not matter for larger lottery wins-
It still matters, although less so the higher you go. You pay 35% only for money earned above the amount that puts you in the top tax bracket, just like you pay 33% only on that money between the top of the 28% tax bracket and the bottom of the 35% bracket, etc.
So, for example, $120,000 of taxable income (after deductions, of course) should cost you (assuming you are married or head of household):
This works out to $23,780.50, for an effective rate of 19.82%.
As for the $8M jackpot, lets assume a payout of $4M, or 26 equal payments of $307,692. Taxes on the $4M are $1,375,206.50, or about 34.38%. Taxes on the $307,692 are $53,314, or about 17.33%. I’ll take the payments, thank you very much!
I deliberately didn’t raise the tax issue, for a number of reasons.
First, my understanding of U.S. Federal Tax is that if you have a CHOICE in the form of payment (lump sum or annuity), you are taxed as though it was a lump sum. You can’t avoid taxes by asking for delay. And, of course, if you don’t have any choice, then the question of “which is better” is moot. Now, the rules may be different for a state lottery, I didn’t look that up, I made the assumption that taxes would be irrelevant. I will try to check that, or someone else can verify.
Second, it is generally advantageous to receive payments spread over time, since the effective tax rate will be lower, even if the marginal rate is the same. That’s 5cents’s calcuations (which I haven’t checked, but I believe him.) HOWEVER, those calculations assume that the tax rates will remain the same over the period of payments. If the tax rates go up or down during the 20-year period, all bets are off. At present, I think it highly unlikely that U.S. tax rates will remain this low, but who knows? In any case, trying to predict future tax rates in order to determine your best options for payments seemed to me to be futile.
Oops, forgot that little detail. You’re right. In the $8M jackpot example I gave, the taxes on the lump sum are 34.38%, so your annuity payment of $307,692 get whacked with a tax of $105,785 leaving you with a paltry $201,907.
Not intending to politicize or hijack this thread, but if I were a betting man (and I’m not, so I don’t buy lottery tickets), I’d wager the same way you are. Without massive changes, Medicare and Social Security for baby boomers is going to make the current deficit look puny.