Financial analyst looks at lottery jackpot cash/annuity options

Aug 23, 2005, 6:06 pm (18 comments)

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Q: I've just won a $50 million lottery. Should I take all cash or an annuity?

A: It depends on a lot of things, one of which is the interest rate the lottery uses in calculating the annuity value vs. the immediate payout. Another is the uncertainty associated with future income taxes.

The conventional wisdom is to take the money as a lump sum. That's because the lottery takes the cash prize (today's dollars) and uses that money to buy investments that will fund the annual payments. That may mean that the lottery buys the winner(s) an annuity, or it may buy bonds with maturities that roughly match the payment schedule.

A recent Powerball jackpot winner chose a one-time, pretax cash payment of $34,662,300.66 vs. $59.5 million in 30 annual payments with the first payment at the beginning of year one. This equates to an annual interest rate of about 4.26 percent.

The real lesson here is a multimillionaire can afford to pay for professional advice. If you don't have one already, find an accountant, an attorney and a money manager that you trust to help you manage this newfound wealth. Congratulations!

Bankrate

Comments

Just6ntlc

If I win a $50 million jackpot. I would take the cash option. Definately, I would find an accountant to help our family situations.

winner2b

umm...how about showing some calculations or some tables?!?  I think we all know, if we win huge sums we can afford Pro. advice.

tg636

I wish we could have a more detailed and definitive answer with a real case study with taxes, interest, money spend on living vs. money tied up in investments and inflation factored in to finally get a good answer to this vexing question.


ChazzMatt

"A recent Powerball jackpot winner chose a one-time, pretax cash payment of $34,662,300.66 vs. $59.5 million in 30 annual payments with the first payment at the beginning of year one. This equates to an annual interest rate of about 4.26 percent."

The only thing wrong with that analysis is I would BET the PowerBall winner would NOT have $34.6 million to invest by the end of the month.  He might have 30 million or 25 million.  THEN, he would invest the rest.  You have 34.6 million and you are going to go buy a couple of cars, a couple of houses, some new clothes, help out the family some -- only later do you wonder where $10 million went!  (Ask Mike Tyson where all his millions went, he now lives in a 2-bedroom house in Arizona.)  Whereas if you take the annuity, you have some breathing room to adjust, and even if you blow a lot the first year, the damage is limited -- and you have 29 more years to do it right. 

Rip Snorter

"A recent Powerball jackpot winner chose a one-time, pretax cash payment of $34,662,300.66 vs. $59.5 million in 30 annual payments with the first payment at the beginning of year one. This equates to an annual interest rate of about 4.26 percent."

The only thing wrong with that analysis is I would BET the PowerBall winner would NOT have $34.6 million to invest by the end of the month.  He might have 30 million or 25 million.  THEN, he would invest the rest.  You have 34.6 million and you are going to go buy a couple of cars, a couple of houses, some new clothes, help out the family some -- only later do you wonder where $10 million went!  (Ask Mike Tyson where all his millions went, he now lives in a 2-bedroom house in Arizona.)  Whereas if you take the annuity, you have some breathing room to adjust, and even if you blow a lot the first year, the damage is limited -- and you have 29 more years to do it right. 

You might well be right.  The Powerball winner might actually make the choice to spend some of the money that belongs to him, reducing the remainder of the sum that belongs to him.

You're certainly correct in asserting that he doesn't have the option if he assigns the responsibility for his fiscal decisions to the benevolent hands of Powerball officials for the duration.  The British aristocracy used to do that with their erstwhile sons..... give them an annual allowance to protect them from their follies.  Worked pretty well, I suppose, although I doubt the erstwhile sons ever made the decisions to do it that way.  But they weren't smart enough to be American lottery winners.

I agree with the earlier poster who suggested this would be more helpfully examined with some charts, tables and calculations.

But one thing is certain.  The actual amount of the jackpot is the amount the winner takes in lump sum.  The advertised amount of the jackpot, as it differs from the actual amount, is nothing other than interest accumulated on that amount.  A jackpot winner who takes the annuity is merely delegating his financial security into the hands of lottery officials, rather than investing the money himself.

Sort of akin to buying US Savings Bonds back when the interest rates on them were about 1.5 percent unless you left them until maturity a couple of decades later, at which time they'd pay a merely REALLY LOW interest rate compared to other investments.  Patriotic, easy, and not particularly advantageous to the investor.

Jack

Jack

Todd's avatarTodd

Jack,

I think ChazzMatt's point was that if the winner chose the annuity option, they may do better than the person who blows a large amount of his/her winnings, because they will have more of their initial money remaining for investment purposes.

Hence, in the real world of people winning and spending, perhaps the person choosing annuity does in fact come out ahead.

Rip Snorter

Todd:

I'd guess you're probably right on both counts. 

Probably that was the point ChazzMatt was making, and probably some winners would come out better financially by putting their money outside their control where they can't make decisions involving spending it, or investing it in places where the risk is higher, along with the returns.

If a jackpot winner is young, or if he's young enough to have a the probability of a lot of years left, investing it anywhere at all where he can't spend it all up for 30 years will probably assure he'll still have some money after 29 years.

At 62, I find it difficult to put myself into any mindset involving 30 year investments, so my perspectives on it will be inevitably warped.

Jack

 

fxsterling

tyson is a fool .......... did,nt he see rocky

 

ipodmini1's avataripodmini1

how about just buy a stock index fund and lock in for 25 to 30 years? from past performance, you can get at least 10%/year. everybody can do that. annuity is NOT an option.

ChazzMatt

Yes, my point was that everyone who compares "annuity vs. cash option" treats it like a theoretical problem in accounting, without considering real world factors.  You have 34 million in cash, and you are NOT going to immediately go invest it in stocks and bonds without spending a penny.  Also, a lot of investments you make do tie up your money, so you aren't going to invest ALL of it.  You are going to spend some, invest some.  And you might spend more than you should, due to the emotions of the moment. 

Better to take the annuity, limit any foolish behavior, and then INVEST any of the annity that you don't spend.  It's only for 30 years.  You want that income to continue until you die. 

Back to my point.  When you consider how to get the most return in the "annuity vs. cash option" debate you should really make it "annuity vs. cash option, minus a few million dollars."  :)

 

Rip Snorter

Speak for yourself, amigo.

Thirty years is a long time to trust strangers with what's yours.  Most people  would probably prefer to take risks with their own bad judgement than trust to that of strangers.  Those who don't want to risk taking personal responsibility for their wealth already take the annuity.

I can easily understand how you might prefer to choose to take the annuity if that's how you view reality and measure your own ability to handle your responsibilities, your ability to behave wisely. 

But it's surprising is to see your evangelical attitude about something that's so much a matter of personal choice, self esteem, personal responsibility.  Entirely an individual matter. 

For you to suggest that a person other than yourself believe he isn't capable of handling his own affairs seems a bit much.  I can't help wondering why you're doing it. 

Are you, perhaps, one of the LP members who is also a lottery employee?

Jack

 

Rip Snorter

how about just buy a stock index fund and lock in for 25 to 30 years? from past performance, you can get at least 10%/year. everybody can do that. annuity is NOT an option.

It is for the people who offer the annuities as representative of the value of the jackpot.  It is for the people who want to have control of those annuity funds for thirty years.  For them it's the only reasonable option.

Jack 

mtncharlie

    It seems as though no one really has a notion as to what the "proper" thing to do is; that's human nature. The best thing to do is what YOU think is best for you. However, you might want to consider getting professional help from a financial lawyer, and an accountant.    As to the question of "Lump Sum" or "Annuity",  I have not seen anyone address the "Tax" situation.  In most cases, if a lottery winning is taken as an annuity, the proceeds are generally considered "income", and with a good tax lawyer and some tax dodges you can figure on paying approximately 30%.  Taken as a "Lump Sum" however,  the proceeds are generally considered "Capital Gains" which CAN be taxed at a rate up to 78%.  Now, taking that "worst case" scenario, your 34.5 million dollars, suddenly becomes $7,625,000.  Now, if you foolishly went out and "binged", (et al) buying all your friends new cars, houses, sailing boats, etc., and you blew, say, 10 million, you woiuld find yourself in the predicament of having to come up with  $2,375,000.00 just to keep out of one of Uncle Sams nice Federal Prisons. Now what do you think all those "friends" are going to do when faced with the prospect of losing all those nice "gifts" you gave them?  They won't even remember who you are!  You will end up in worse shape than you started out, and with no friends to boot.  You may think this is all a "what if", but it really did happen.  The moral is: do what YOU think is best, but don't rely solely on your own judgement because it MAY not be as good as you think.                                                                                                                  MC

ChazzMatt
I'm just saying the annuity protects your money and gives a larger guaranteed income even if it's somewhat smaller than the "theoretical" maximum if you invested all the cash yourself.  I'm just saying that theoretical maximum will probably never be seen because you will have less cash to invest.  The "real world" maximum is probably the annuity and you know it's coming every year. 
No, I don't work fo the lottery.  The lottery doesn't care what you do with your money, they don't make any money off whether you take the cash or invest take the annuity.  They make money by selling you the ticket in the first place.  But, they do hate to hear the "he was rich for two years but now works at McDonalds" stories.  Makes them look bad, like somehow it's their fault even though it's not. 
This thread is actually in response to the guy who always screams that cash is the only sensible option, but it's not.  If I won, I might take the cash, I might not.
Right now the jackpot for Mega is at $97 million.  Taking the annuity, that's $3 million per year AFTER taxes, for 26 years.  That's take home.  I could live on half that, invest the remainder each year (maybe in annuities, maybe in stocks....), but no matter what I would be guaranteed that $3 million per year for a long time.  Whereas the cash option after taxes is $47 million. How much of that am I going to spend and how much am I going to invest?  What if I lost a major portion in bad investments?  What if I spent more than I should?  Rather than having 3 million per year for 26 years -- guaranteed -- I might just end up with $5 or $6 million total and have to eke out an existance on that.  Sure that's more than most people have, but considering what I could have had if I'd been a little more prudent... 
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