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Tax Strategies For Lottery Winners - Lump Sum vs Installments

Topic closed. 22 replies. Last post 4 years ago by weshar75.

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socalgal's avatar - bobblecars3
California
United States
Member #103563
January 3, 2011
56 Posts
Offline
Posted: January 12, 2011, 3:24 am - IP Logged

The article below is written by a CPA and Tax Expert from California.  He explains pros/cons from both sides of the payout.

 

Tax Strategies For Lottery Winners – Lump Sum vs. Installments?

The most frequently asked questions from lottery winners and those who just dream about being a winner is: 

“Should I take a lump-sum or installments?”

Take the installments! 

Despite everyone telling you to take the lump-sum.  Your heirs will receive the balance if you die before collecting all the payments and at least 65% of your lump-sum amount will be gone within the first year due to discounting and taxes.

A lump-sum winning will typically get reduced by 45% or more for the time value of money (acceleration by 2o+ years) and then the net amount is further reduced by approximately 35% or more for taxes — leaving a net amount of 35% or less of the gross winnings.

Installment collections will only generally only be subjected to the federal tax hit (depending on state rules) and the taxes are paid over the collection period.  In effect, each payment includes a layer of interest earning and once the amounts are received, the recipient is free to make their own investment decision on those funds.

For jackpot allocations under $10 million, a lump-sum might be considered, but in the vast majority of larger prize winnings, installment payments offer significant benefits, including:

 - greater income, gift and estate tax planning opportunities,

 - significantly reduced  income, gift and estate tax rates,

 - increased budgeting and retention of winnings,

 - reduced probability of family, friends and scammers accessing your winnings.

Following is a summary of the key points to consider:

Up until a few years ago, California Lotto players were forced to make that election at the time they bought their Lotto ticket – which was all the more difficult since the player had no idea of what specific prize they might win (e.g. sole winner, vs. shared prize, etc.).  Now both SuperLotto and MegaMillions winners can make the election within 60 days of winning – so there is time to evaluate options.  The default payout if no election is made is a 26 year payout.

Installment payouts are made annually over a 26 year period beginning at 2.5% of the gross Lotto prize and then increasing to 5.1% in the 26th year.   And despite general confusion on this issue, if you die before receiving your entire payout, your heirs are entitled to receive it – unless the Sacramento legislators decide they might be more worthy recipients.

For a number of economic and tax reasons, my advice for the vast majority of taxpayers winning more than $10 million dollars is to take the winnings in installments.

 

There are a couple of negatives to installments:

1) If interest rates and/ or tax rates jump up, having your pay-out locked into an annuity format may work against you,

2) If the winner (and their spouse if married) pass away during the first few years of the payout, a large estate tax obligation may materialize before funds are accumulated.  Life insurance and loans may be structured to mitigate this issue.

 

The first advantage of an installment payout is saving yourself from the grief of  the double-whammy of:

 -  A “present value” discount from the state of 45% to 55% off the jackpot winnings to take into account the fact that the state is accelerating the payments for up to 26 years.  Therefore a $100 million jackpot becomes a much less exiting  $50 million (before taxes). 

-   Some good news – the state does not tax the Lotto winnings (but will tax interest and dividends earned on your winnings). However, the IRS will withhold at least 25% in taxes (applied after the present value discount)  before you get your net check.  Now the $100 million is sitting at approximately $37.5 million ($50M x 75% after-tax).  And things will get worse when you end up paying another 10% ($5 million in this case) or more in federal taxes when you file your return for the year you won – since the maximum federal rate is 35% and the IRS may have only withheld 25%.

 

1.  Since the vast majority of winners end up  blowing most or all of the money for a variety of reasons, electing installment payments forces discipline for the winner to preserve their winnings and not go out on a spending (and/or giving) binge  – although even an installment winner can accumulate large mortgages and other debt.

2.  Another advantage of installments  is effectively locking into a guaranteed rate of return on the deferred winnings.  The specific rate of earnings is dependent upon what the bond market yields are at the time the state purchases the underlying bonds to support the payout.  Therefore, current investment yields will be less than a few years ago.  The downside of locking into an installment payout is that if rates rise or you believe you can consistently make better investment decisions, a lump-sum payout will give you that option – but be forewarned your investable to secure future investment earnings will be a fraction of what it is by leaving the winnings in the installment form.

3.  If the above reasons are not enough, then another huge advantage of the installment option is the ability to apply long-term tax planning to your new-found wealth.  For example, if you receive a net $50 million in 2010, there is not much you can do to shelter such a large amount of money in a single year.  However, if you receive $2.5 Million to $5.1 million per year, which would be the case for a $100 million winner, there are various legitimate ways to mitigate the annual tax bite by offsetting the annual payments with retirement plan contributions, possible operating losses from active businesses the winner may be involved in, as well as mortgage interest, property taxes and charitable contributions.  While full sheltering will seldom be possible on large winnings, a material reduction in overall tax liability is often possible.  Even with likely rising tax rates, having time to implement these strategies is well worth the exposure to (future) higher tax rates.

4.  Many families and some groups of employees have a history of playing the Lotto under a verbal (or in rare cases written) agreements to split winnings amongst participating members.   The conclusion as to whether there was a pre-arranged “partnership” to share the winnings is very fact specific, but the courts routinely uphold these verbal arrangements to split winnings.  This can offer very significant income, gift and estate tax advantages within a family unit – but can also raise huge issues within the family or co-worker ranks.  Depending on the size of the group and the amount of the specific Lotto prize awarded, a determination can be made whether the installment method or lump-sum makes the most sense for the group or specific winners.  This can get complex and it is unclear which specific fact patterns the Lottery Commission will honor and when “master” elections and “sub-elections” can be made by the winners.

5.  There are numerous issues (including pre- and post- win residency status, estate and gift planning, verbal contracts, etc.) which arise for these lucky winners and before too many promises and plans are made, before claiming the prize and making the lump-sum or installment election the winners should contact a qualified attorney, investment adviser and tax adviser and meet with them as a group to insure that all the options  and complexities are fully evaluated.

    sully16's avatar - sharan
    Listens to the wind
    Michigan
    United States
    Member #81740
    October 28, 2009
    20582 Posts
    Offline
    Posted: January 12, 2011, 6:01 am - IP Logged

    It's whatever best suits your needs, for some people taking the installment plan seems to make it easier to handle the vast wealth.

    There's only one US Flag


      United States
      Member #101815
      December 9, 2010
      3 Posts
      Offline
      Posted: January 12, 2011, 9:03 am - IP Logged

      Thanks for posting this. Good info.

      In Texas we must select the "cash value option" at the time of ticket purchase if you want the cash.

      TLC states "You must select the “Cash Value Option” at the time of your purchase; otherwise, the “26 Annual Payments” option will apply to your ticket." 

      To be safe I always mark my payment option at the time of purchase. You never know what the clerk will do for you.

        savagegoose's avatar - ProfilePho
        adelaide sa
        Australia
        Member #37136
        April 11, 2006
        2829 Posts
        Offline
        Posted: January 12, 2011, 9:29 am - IP Logged

        i like the taking  annuities then claiming poverty option to avoid giving family members too much.

         

        seriously tho, with a large win like 100 mill, annuity payments would be ewnough for me to live off the interest, after 1st year,  you would get teh 2nd annuity, and live off the interest of both amounts, having double the income to budget on.

         

        by the time you get to yoear 5, you would start to become accustomed to being rich and by year 10 you would have  it down pat.

        a good way to ease yourself into being insanely wealthy,

        2014 winnings S= spent W= won

        JAN S 119/ W71 ; FEB S90 /W 13 ; MAR S93/ W75 ; APR S146/ W50 ; MAY S94/ W32 : JUN S98 /W 13 JUL S110 /W21 ; AUG S185 / W56 ; SEP S 140/W 13 ; OCT S 130 / W 66 ; NOV S104 / W47

        S $1313W $461Tot -$851

         

         

          BaristaExpress's avatar - BaristaExpressMX zpsfb0d8b5d.png
          Magnolia, Delaware
          United States
          Member #18795
          July 20, 2005
          789 Posts
          Offline
          Posted: January 13, 2011, 10:16 pm - IP Logged

          The article below is written by a CPA and Tax Expert from California.  He explains pros/cons from both sides of the payout.

           

          Tax Strategies For Lottery Winners – Lump Sum vs. Installments?

          The most frequently asked questions from lottery winners and those who just dream about being a winner is: 

          “Should I take a lump-sum or installments?”

          Take the installments! 

          Despite everyone telling you to take the lump-sum.  Your heirs will receive the balance if you die before collecting all the payments and at least 65% of your lump-sum amount will be gone within the first year due to discounting and taxes.

          A lump-sum winning will typically get reduced by 45% or more for the time value of money (acceleration by 2o+ years) and then the net amount is further reduced by approximately 35% or more for taxes — leaving a net amount of 35% or less of the gross winnings.

          Installment collections will only generally only be subjected to the federal tax hit (depending on state rules) and the taxes are paid over the collection period.  In effect, each payment includes a layer of interest earning and once the amounts are received, the recipient is free to make their own investment decision on those funds.

          For jackpot allocations under $10 million, a lump-sum might be considered, but in the vast majority of larger prize winnings, installment payments offer significant benefits, including:

           - greater income, gift and estate tax planning opportunities,

           - significantly reduced  income, gift and estate tax rates,

           - increased budgeting and retention of winnings,

           - reduced probability of family, friends and scammers accessing your winnings.

          Following is a summary of the key points to consider:

          Up until a few years ago, California Lotto players were forced to make that election at the time they bought their Lotto ticket – which was all the more difficult since the player had no idea of what specific prize they might win (e.g. sole winner, vs. shared prize, etc.).  Now both SuperLotto and MegaMillions winners can make the election within 60 days of winning – so there is time to evaluate options.  The default payout if no election is made is a 26 year payout.

          Installment payouts are made annually over a 26 year period beginning at 2.5% of the gross Lotto prize and then increasing to 5.1% in the 26th year.   And despite general confusion on this issue, if you die before receiving your entire payout, your heirs are entitled to receive it – unless the Sacramento legislators decide they might be more worthy recipients.

          For a number of economic and tax reasons, my advice for the vast majority of taxpayers winning more than $10 million dollars is to take the winnings in installments.

           

          There are a couple of negatives to installments:

          1) If interest rates and/ or tax rates jump up, having your pay-out locked into an annuity format may work against you,

          2) If the winner (and their spouse if married) pass away during the first few years of the payout, a large estate tax obligation may materialize before funds are accumulated.  Life insurance and loans may be structured to mitigate this issue.

           

          The first advantage of an installment payout is saving yourself from the grief of  the double-whammy of:

           -  A “present value” discount from the state of 45% to 55% off the jackpot winnings to take into account the fact that the state is accelerating the payments for up to 26 years.  Therefore a $100 million jackpot becomes a much less exiting  $50 million (before taxes). 

          -   Some good news – the state does not tax the Lotto winnings (but will tax interest and dividends earned on your winnings). However, the IRS will withhold at least 25% in taxes (applied after the present value discount)  before you get your net check.  Now the $100 million is sitting at approximately $37.5 million ($50M x 75% after-tax).  And things will get worse when you end up paying another 10% ($5 million in this case) or more in federal taxes when you file your return for the year you won – since the maximum federal rate is 35% and the IRS may have only withheld 25%.

           

          1.  Since the vast majority of winners end up  blowing most or all of the money for a variety of reasons, electing installment payments forces discipline for the winner to preserve their winnings and not go out on a spending (and/or giving) binge  – although even an installment winner can accumulate large mortgages and other debt.

          2.  Another advantage of installments  is effectively locking into a guaranteed rate of return on the deferred winnings.  The specific rate of earnings is dependent upon what the bond market yields are at the time the state purchases the underlying bonds to support the payout.  Therefore, current investment yields will be less than a few years ago.  The downside of locking into an installment payout is that if rates rise or you believe you can consistently make better investment decisions, a lump-sum payout will give you that option – but be forewarned your investable to secure future investment earnings will be a fraction of what it is by leaving the winnings in the installment form.

          3.  If the above reasons are not enough, then another huge advantage of the installment option is the ability to apply long-term tax planning to your new-found wealth.  For example, if you receive a net $50 million in 2010, there is not much you can do to shelter such a large amount of money in a single year.  However, if you receive $2.5 Million to $5.1 million per year, which would be the case for a $100 million winner, there are various legitimate ways to mitigate the annual tax bite by offsetting the annual payments with retirement plan contributions, possible operating losses from active businesses the winner may be involved in, as well as mortgage interest, property taxes and charitable contributions.  While full sheltering will seldom be possible on large winnings, a material reduction in overall tax liability is often possible.  Even with likely rising tax rates, having time to implement these strategies is well worth the exposure to (future) higher tax rates.

          4.  Many families and some groups of employees have a history of playing the Lotto under a verbal (or in rare cases written) agreements to split winnings amongst participating members.   The conclusion as to whether there was a pre-arranged “partnership” to share the winnings is very fact specific, but the courts routinely uphold these verbal arrangements to split winnings.  This can offer very significant income, gift and estate tax advantages within a family unit – but can also raise huge issues within the family or co-worker ranks.  Depending on the size of the group and the amount of the specific Lotto prize awarded, a determination can be made whether the installment method or lump-sum makes the most sense for the group or specific winners.  This can get complex and it is unclear which specific fact patterns the Lottery Commission will honor and when “master” elections and “sub-elections” can be made by the winners.

          5.  There are numerous issues (including pre- and post- win residency status, estate and gift planning, verbal contracts, etc.) which arise for these lucky winners and before too many promises and plans are made, before claiming the prize and making the lump-sum or installment election the winners should contact a qualified attorney, investment adviser and tax adviser and meet with them as a group to insure that all the options  and complexities are fully evaluated.

          Yes higher tax rates in the future and don't forget the biggest factor of all when it comes to any currency in the world! "The Value the world puts on that Currency!"  I'll take my dollar at todays value rather than the uncertain value 10 - 15 and 26 yrs. down the road plus adding in the higher tax rate on top of it!

          As the old saying goes "A bird in the hand is worth two in the bush" will always hold true anywhere in the world, no matter where you go!

          And think about this one while you're at it! Only the blind/foolish believe whole heartly that their government has the "People's" best interest at Heart! And if you believe that one I have a bridge to sell you with beach front property! Green laugh

          Now listen up people who are so called pro advocates of the annuity junk/crap! Even JG Wentworth says and I quote "It's your money" use it now when you need it! Yes, that guy will give you cash for all or part of your future payments (10 cents on the dollar) And be laughing at you all the way to the bank! Why? Because only a fool would except annuity payments especially when it comes to the lottery!

          Now when it comes to the insurance companies and settlement payments, you might not have any choice in the matter, so take it and wait it out and get all of it you can over time! But when talking about the lottery and having a choice in what to take, the smart ones will take the cash payout and not the annuity!

          NO THANKS TO AN ANNUITY! CASH IS THE UNDISPUTED KING OF THE WORLD!

          There is No Valid Reason To Take An Annuity When It Comes To Winning The Lottery!

          Keep dreaming the impossible dream, it just may come true! Thumbs Up

            ttech10's avatar - blobdude
            Texas
            United States
            Member #92332
            June 5, 2010
            783 Posts
            Offline
            Posted: January 14, 2011, 12:45 am - IP Logged

            Thanks for posting this. Good info.

            In Texas we must select the "cash value option" at the time of ticket purchase if you want the cash.

            TLC states "You must select the “Cash Value Option” at the time of your purchase; otherwise, the “26 Annual Payments” option will apply to your ticket." 

            To be safe I always mark my payment option at the time of purchase. You never know what the clerk will do for you.

            In my experiences it's that the Cash Value option applies to your ticket unless you state otherwise you want the Annual Payments. I've gotten tickets many times where they don't ask and it's always Cash Value.

              savagegoose's avatar - ProfilePho
              adelaide sa
              Australia
              Member #37136
              April 11, 2006
              2829 Posts
              Offline
              Posted: January 14, 2011, 7:09 am - IP Logged

              yeah barrista ,  i wouldnt take the annuity, im just  saying the only reason to as i see it, is as i explained earlier. in a ideal world with resposible gov and no fraudster banks. and a set tax rate you can rely on. maybe id take an annuity.

              but its take the money and run for me.,

              2014 winnings S= spent W= won

              JAN S 119/ W71 ; FEB S90 /W 13 ; MAR S93/ W75 ; APR S146/ W50 ; MAY S94/ W32 : JUN S98 /W 13 JUL S110 /W21 ; AUG S185 / W56 ; SEP S 140/W 13 ; OCT S 130 / W 66 ; NOV S104 / W47

              S $1313W $461Tot -$851

               

               

                Avatar
                New Member

                United States
                Member #104182
                January 10, 2011
                3 Posts
                Offline
                Posted: January 14, 2011, 2:33 pm - IP Logged

                Inflation will kill the value of the annuity payments

                  Avatar

                  United States
                  Member #34931
                  March 9, 2006
                  68 Posts
                  Offline
                  Posted: January 14, 2011, 2:56 pm - IP Logged

                  Never can tell when "the rules of the game" will change (sometimes retroactively) . . example.

                    socalgal's avatar - bobblecars3
                    California
                    United States
                    Member #103563
                    January 3, 2011
                    56 Posts
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                    Posted: January 14, 2011, 8:01 pm - IP Logged

                    Even though he says to cash out up to 10mil, that wouldn't be the best option for everyone.  If you're a retiree, it's better to cash out no matter what the jackpot is.  Enjoy the money because you never know if you will still be around in 26 years.  If you're young, then I can see how annuity can help you mature money-wise.

                    Also, Obama's extension on tax breaks is only until 2012.  Tax brackets will change for the wealthy. 

                    I wouldn't be surprised if California ends up following Illinois and raise taxes.  A lot of people would move out of state.

                      savagegoose's avatar - ProfilePho
                      adelaide sa
                      Australia
                      Member #37136
                      April 11, 2006
                      2829 Posts
                      Offline
                      Posted: January 15, 2011, 3:04 am - IP Logged

                      wow if the gov gets to change the tax rules after you win lotto and decide lump sum or annuity, then you should get to change how you want paid 3 months after they change their mind how things work.

                      2014 winnings S= spent W= won

                      JAN S 119/ W71 ; FEB S90 /W 13 ; MAR S93/ W75 ; APR S146/ W50 ; MAY S94/ W32 : JUN S98 /W 13 JUL S110 /W21 ; AUG S185 / W56 ; SEP S 140/W 13 ; OCT S 130 / W 66 ; NOV S104 / W47

                      S $1313W $461Tot -$851

                       

                       


                        United States
                        Member #104974
                        January 23, 2011
                        24 Posts
                        Offline
                        Posted: January 31, 2011, 6:33 am - IP Logged

                        Anyone who wins should take the lump sum. Within the next 26 years, there will be tax hikes and high inflation, why get locked in with the annuity? Having control of your money allows you to make changes should new factors get added to the equation.

                          dallascowboyfan's avatar - tiana the-princess-and-the-frog.jpg
                          Oklahoma
                          United States
                          Member #82391
                          November 12, 2009
                          5516 Posts
                          Offline
                          Posted: January 31, 2011, 9:04 am - IP Logged

                          I say do what is best for you and your family...... everybodys situtation is diffrent

                            Coin Toss's avatar - shape barbed.jpg
                            Zeta Reticuli Star System
                            United States
                            Member #30470
                            January 17, 2006
                            9210 Posts
                            Offline
                            Posted: January 31, 2011, 10:24 am - IP Logged

                            Someone here on LP (I'm sorry I forget who) has or had a signature, "You can always buy a better anuity".

                            I think that's pretty good info, the state or the MUSL doesn' have making sure you get the best deal in mind.

                            There's good info in socalgal's OP but it sounds to me like that CPA can't "get outside the box" in their thinking.

                            For one thing, there have been too many instances where a jackpot winner takes an annuity and later on is approached by or they go to one of those companies that buy annuities and sell theirs for pennies on the dollar. Despite having chosen the annuity from the lottery at some later time they decide "I want the money right now" after all.

                            Also, as BaristaExpress said,  whatever you get paid right now is worth what it's worth right now. Over the course of many years an annuity that at one time could oay for a house or two with its annual payment may barely pay for a car many years down the road. (Of course this depends on the size of the jackpot).

                            As they say in the Vegas football season contests "Cash is king".

                            Just my $.02

                            PS

                            How different this would all become if the U.S. copied Canada, Britian, Australia and others when it came to not taxing gambling winnings.

                            Bang Head

                            Those who run the lotteries love it when players look for consistency in something that's designed not to have any.

                            Lep

                            There is one and only one 'proven' system, and that is to book the action. No matter the game, let the players pick their own losers.

                              savagegoose's avatar - ProfilePho
                              adelaide sa
                              Australia
                              Member #37136
                              April 11, 2006
                              2829 Posts
                              Offline
                              Posted: January 31, 2011, 10:32 am - IP Logged

                              id suggest goinbg to a local community group at the leasst and signing up for a 4 week budgetting course.

                              like maybe expenses <= income.  that should cover staying afloat with annuities.

                              i think there is no sympathy for lotto winners when they blow it, but no one has experienced the pressure from freinds, family  co workers aquaintences, and even bank managers to getat  a chunk of their cash.  evewn bill gates needs a budget. he sure as heck didnt get where he is spending more than comes in

                               

                              .

                              2014 winnings S= spent W= won

                              JAN S 119/ W71 ; FEB S90 /W 13 ; MAR S93/ W75 ; APR S146/ W50 ; MAY S94/ W32 : JUN S98 /W 13 JUL S110 /W21 ; AUG S185 / W56 ; SEP S 140/W 13 ; OCT S 130 / W 66 ; NOV S104 / W47

                              S $1313W $461Tot -$851