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thelottery

PA
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December 22, 2011
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Dec 24, 2011, 12:00 am

*Assuming investing at a fixed rate of return* (certificates of deposit, money market, etc)
do the below numbers look right?

Assuming:
the State in question has no lottery prize tax..

And assuming that interest income is taxed at:
10% by the State, and
30% by the Fed

Using an online Compound Interest Calculator, these numbers came up..

The last MegaMillion annuity was 173 while the lumpsum was 130.
That's a return of 33%, over 26 years.
After taxes - That is 1.1% annual return, with annual compounding interest.

The last PowerBall annuity was 125 while the lumpsum was 80.
That's 56%, over 30 years.
After taxes - That is 1.5% annual return, with annual compounding interest.

If you invest the lump-sum, you'd need to pay taxes on your gains/interest. If the Feds get 30% and the State gets 10%, that leaves 60%.
That means you'd need to invest at:

1.7% compounded annually to match MegaMillion's annuity after-tax returns
and
2.3% coumpounded annually to match PowerBall's annuity after-tax returns
thelottery

PA
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December 22, 2011
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Dec 24, 2011, 12:55 am

Also - with an annuity, you can be investing a portion of each years payment.

Say you invest $1mil each year into a 1.5% CD.
After 26 years you'd have made $4mil in after-tax interest. In 30 years, it'd be $6mil.

When the annuity is $5mil a year, it's easier to save and invest more.
If $2 mil was invested each year at 1.5%
there would be an extra $9mil from the interest, after-tax, after 26 years. Or $12mil after 30 years, after-tax.
Longarm

DFW, Texas
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Dec 25, 2011, 2:17 pm

"If you invest the lump-sum, you'd need to pay taxes on your gains/interest."

Are you including the initial taxes on the jackpot? That's one of the bigger considerations. If the full cash value (minus the first payment) is invested in the annuity, there's no tax paid. That leaves a larger amount to start the investment. Also, less of the annual payments will be taxed at the highest rate compared with the full cash value taxed all at once. That's particularly important if the annual payments aren't multiple millions of dollars, since a higher proportion would be taxed at lower rates. In your math, presuming a fixed rate, the rate of payment doesn't matter, but with actual tax brackets, the less you get in one year the lower the total rate will be.

A big consideration for me is the future tax rates. If rates go up, it may be better to pay today's lower rates on the large jackpots, and then pay the higher future rates on the smaller amounts of returns. I'm not much of a gambler, so I'd probably take cash so I know what the rate will be. I would lose on that decision if rates went down, but I'd rather have certainty and be able to plan better.
kapla

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Dec 25, 2011, 7:09 pm

Another factor to consider is 'If CD/fixed rates of return go up in the future'. If you were to LADDER the CDs then as they come due you could be re-investing them at the NEW higher rate of return. At some point these low fixed rates of return need to rise. That would then CRUSH the annuity payments for returns.
savagegoose

adelaide sa
Australia
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April 11, 2006
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Dec 25, 2011, 7:59 pm

theres a dormula to work out present value i saw it on kahn acadamy

http://www.khanacademy.org/video/present-value-2?playlist=Finance

theres 3 vids on the topic this is number 2

" Still swinging, still missing "
2014 = -1016; 2015= -1409; 2016 = -1171; 2017 = -1257 ; 2018 = - 1380 = TOT = - 6233

keno historic = -2291 ; 2015= -603; 2016= -424; 2017 =-427; 2018= -223 TOT = -3968

:
thelottery

PA
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December 22, 2011
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Dec 25, 2011, 8:55 pm

Longarm,:

The Fed tax on lottery prizes seems to be 25% for every state, so that is a set %.
The tax on interest is also a set percent, depending on the state (some states do not tax interest income).

From what I have read, there are no tax brackets for interest income - just flat rates.
thelottery

PA
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December 22, 2011
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Dec 25, 2011, 9:27 pm

Quote: Originally posted by kapla on Dec 25, 2011
Another factor to consider is 'If CD/fixed rates of return go up in the future'. If you were to LADDER the CDs then as they come due you could be re-investing them at the NEW higher rate of return. At some point these low fixed rates of return need to rise. That would then CRUSH the annuity payments for returns.

Good point. CD rates can change.

This brings up another point:

If the interest rates do rise, then it would be probable that the lottery annuities rates of return would also rise comparably.
- According to the PA lottery website.. The annuities are provided by companies who win the annuity contract. There are several companies trying to get the annuity contracts, so they naturally will offer the most attractive rates... that means their rates will correlate closely with the Fed interest rates.

As for the CD rates ability to change, it really means that the amount of interest generated is really a gamble.

Google for "CODI - Certificates of Deposit Index - Mortage (ARM) indices"
- the first website has a chart of CD rates back to 1990. The current rates are at the lowest level.
But considering that back in 1993, the chart also had a floor where the rates were at a low and looked to be only able to go up from there. They did rise for a few years, but eventually turned back down and went even lower than they were at in 1993.
Same thing happened in 2003.
As for what happens to the current rates... sideways, up, down, all are reasonable possibilities.

But again, if rates go up, the annuity rates will also go up. And if rates go down, then the annuity rates will go down.
The only question is if the annuity rates get adjusted during the annuity... or if they are set at a fixed rate or schedule at the beginning, and won't change afterwards regardless what the Fed interest rate does.
thelottery

PA
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December 22, 2011
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Dec 26, 2011, 1:10 am

After reading more, it appears that:

-some annuities have a interest rate that is fixed for the life of the annuity

-some annuities' interest rate is reset annually

-some of the annuities that are reset, are based not on the Fed or Prime rate or other market rate, but instead are based on the insurance companies yeild on their own investment portfolio which can contain bonds and other interest bearing holdings.

Bottom Line - I sent a question to the PA lottery. Having a clear answer is the best antidoet to endless guessing!
kapla

United States
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July 24, 2010
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Dec 26, 2011, 4:34 pm

Quote: Originally posted by thelottery on Dec 26, 2011
After reading more, it appears that:

-some annuities have a interest rate that is fixed for the life of the annuity

-some annuities' interest rate is reset annually

-some of the annuities that are reset, are based not on the Fed or Prime rate or other market rate, but instead are based on the insurance companies yeild on their own investment portfolio which can contain bonds and other interest bearing holdings.

Bottom Line - I sent a question to the PA lottery. Having a clear answer is the best antidoet to endless guessing!

Should be interesting to see what they say. Also I would bet they leave it open to 'change' in the future so as to be the best for the lottery vs the customer.
JWBlue

San Diego, CA
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February 12, 2008
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Dec 26, 2011, 8:23 pm

Quote: Originally posted by thelottery on Dec 25, 2011
Longarm,:

The Fed tax on lottery prizes seems to be 25% for every state, so that is a set %.
The tax on interest is also a set percent, depending on the state (some states do not tax interest income).

From what I have read, there are no tax brackets for interest income - just flat rates.

Lottery winnings are not taxed as ordinary income?

I almost 100% sure it is.

Also, I am almost sure that interest income is taxed at the ordinary income rate.
Longarm

DFW, Texas
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Dec 26, 2011, 8:53 pm

Quote: Originally posted by JWBlue on Dec 26, 2011
Lottery winnings are not taxed as ordinary income?

I almost 100% sure it is.

Also, I am almost sure that interest income is taxed at the ordinary income rate.

The 25% figure is the initial withholding, not the final tax liability. The final liability depends on the totality of the winner's financial situation. In general, the more income you get in a single year, the more that will fall in the highest bracket.

Also, that's a good point about higher future rates. It's a big risk locking in today's low rates for 26 or 30 years. Of course, if you're getting millions (or hundreds of millions) of dollars, your primary concern should probably be preservation, not growth. But that's an individual decision.
thelottery

PA
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December 22, 2011
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Dec 26, 2011, 10:53 pm

Quote: Originally posted by JWBlue on Dec 26, 2011
Lottery winnings are not taxed as ordinary income?

I almost 100% sure it is.

Also, I am almost sure that interest income is taxed at the ordinary income rate.

Right, the initial taxes on lottery payments are taxed as lottery taxes - Federal at 25%, and state taxes depend on the specific state.

For Interest Income..

I have only checked a few states which I am personally interested in. All of them tax Interest Income at a set percent. This includes interest from CDs.

It's easy to check... just google:
"Interest Income" Tax (state you're interested in)

or any other way to find the state tax website. Another keyword to search for is "Interest and Dividends"
thelottery

PA
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December 22, 2011
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Dec 26, 2011, 11:18 pm

Quote: Originally posted by Longarm on Dec 26, 2011
The 25% figure is the initial withholding, not the final tax liability. The final liability depends on the totality of the winner's financial situation. In general, the more income you get in a single year, the more that will fall in the highest bracket.

Also, that's a good point about higher future rates. It's a big risk locking in today's low rates for 26 or 30 years. Of course, if you're getting millions (or hundreds of millions) of dollars, your primary concern should probably be preservation, not growth. But that's an individual decision.

tolerance for risk

It is a gamble. Unless you are the guy who decides what the rate will be... it's a gamble, an educated gamble at best, hoping that you understand an extremely complex game that involves everything.

There are Bump-Up CDs so you have the ability to bump up to a higher rate if the market rates increase... Variable CDs to track the market's interest rate in case it goes up... Fixed CDs to eliminate the risk if rates decrease...

Certain and fixed annuity payments sure seem more carefree. And for investing the remaining funds, Fixed CDs seem the most worry-free.
thelottery

PA
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December 22, 2011
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Dec 26, 2011, 11:48 pm

Just to note, South dakota has a Federal withholding of 28%, instead of the 25% for other states.

Best to check the exact taxes for a state by going to the state's own lottery site, and their tax site.

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