Should You Take The Lump Sum Or Annuity If You Win Lotto?

Winning the lotto is a life-changing experience. But according to some guesstimates, up to 70% of lotto winners end up broke. Having a good plan and team of advisors is crucial if you win the jackpot. And one of the major decisions is how you want to receive your winnings, as a lump sum or an annuity.

We think the annuity is the better choice for the majority of people. The data is hard to come by, but anecdotally many of the winners who go broke opted for the lump sum payout.

If you take all your winnings at once, not only do you receive much less money overall, but you have one chance. If you mismanaged your winnings, you can be broke since you have no new money coming in.

The annuity payout option may be less exciting. But it gives you 30 chances over 30 years to manage a smaller, but growing, amount of money.

However, there is much more to the decision.

Lump Sum Cash Prize vs. Annuity

When you win the mega lottery (Powerball and MegaMillions), you have 2 options on how to receive your grand prize. Both mega lotteries have very similar options. (See MegaMillions payout options and Powerball payout options). You can take the entire amount as a lump sum or you can take it as an increasing annuity.

Normally, you’d prefer to take money today rather than at some future point in time. This concept is called the Time Value of Money and is a fundamental concept in finance.

However, the lotto accounts for the time value of money already. The headline number you see is the total payments from the annuity option.

However, if you take the lump sum you would receive a much smaller amount today. As shown, the lump sum cash value can be around 1/2 of the total annuity payments

In this post, we will cover how is each payout option treated and what are the pros and cons of both?

How Lotto’s Lump Sum Cash Prize Is Calculated

To get the cash value amount, the lottery foundation will figure out the price you would pay today to purchase an annuity with the equivalent cashflows as the annuity payout option.

The lump sum amount is typically around half of the advertised headline jackpot number. But it changes depending on where interest rates are.

In theory, you could take the lump sum prize, go to an insurance company and purchase a 30 year annuity and get the same cashflow as the annuity option. (Note, since insurance companies earn a profit on annuity sales, this may not work in real life).

How Lotto’s Lump Sum Cash Prize Is Taxed

If you elect to receive the lotto payout as a lump sum cash prize, you will have an automatic 24% tax withholding before you receive the money. This further reduces the actual money received from the headline. In the above snapshot, a $76 million lotto jackpot was $38.2 million lump sum.

But you would only receive $29 million as 24% tax would be withheld, ($8.2 million).

That isn’t all of it though. When you file your taxes, you will need to pay any additional tax at that time. Currently, that would likely be 37% since a mega lotto jackpot win puts you in the highest tax bracket.

Therefore, come tax time, you would need to pay another 13% tax on the lump sum amount, or ~$5 million.

None of the above taxes take into account any state tax. You need to claim your lotto win in the state you purchased the ticket. If that state has an income tax you could be paying upwards of 15% more taxes to the state.

In the end, your $76 million jackpot would be closer to $24 million after the lump sum discount and federal taxes but before any state tax. This is about 1/3 of the actual headline number.

How The Lotto’s Annuity Is Paid Out

If you elect to take the lotto prize as an annuity, you will have your money disbursed over 30 separate payments. Both MegaMillions and PowerBall currently pay an increasing annuity. This means that each payment with be approximately 5% larger than the last one.

For example, for the $76 million jackpot, your first payment would be ~$1,143,000 or $1.14 million. Your next payment in a year would be 5% larger, $1.2 million. This would continue till your 30th payment in 30 years that is $4.7 million.

If you added each of the 30 payments from $1.14 million to $4.7 million, you would get $76 million.

Since each payment is smaller than the lump sum option, you would pay less overall taxes under the current tax system in the US. However, if taxes go up in the future, you may wind up paying more overall taxes later.

Pros & Cons of Selecting The Lump Sum Cash Lotto Jackpot

Despite getting ~1/3 or less of the advertised jackpot after the lump sum discount and taxes, there are benefits to taking all the money at once. For one, you get the opportunity to invest it and if markets do well that money can grow. You also may think taxes are going to increase in the future so locking in today’s tax rate is prudent.

Below are the pros and cons of selecting the lump sum cash payout.

Benefits of Lump Sum Payout Option

• Known tax rate: You will know exactly the after-tax value of your reward as you know the current tax rates and brackets.
• Higher potential investment returns: If you invest the lump sum, you may be able to achieve high returns and have more money over the course of your life.
• Immediate access to all your funds: You don’t need to wait to have access to all your funds to do what you want.

Downsides of Lump Sum Payout Option

• Only get one shot: If you take all your money at once and spend it all on items and poor investments, you have no more income. This is the lotto winner’s curse.
• Large initial tax: You will be paying a large tax upfront on your earnings.
• Lower total payment: You get less than the advertised jackpot amount. The lump sum is a discounted payment that is often ~50% of the headline jackpot number.
• No time to adjust to new lifestyle: Getting a large windfall immediately puts you in a different financial world. With no time to adjust you may make some major missteps
• Poor investments can destroy wealth: Although the stock market has historically increased over long periods of time, there have been period of large negative returns. If the timing of your investments is poor, you can lose a significant portion of your wealth.

Pros & Cons of Selecting The Annuity Lotto Jackpot

When you select the annuity option, you will get more total dollars. However, you will receive that money spread out over a 30 year period. The biggest benefit is that the annuity option makes it harder to go broke and forces you to control your spending. Each year you get another large paycheck meaning even if you blow all the money one year you have more coming.

Below are the pros and cons of the annuity option.

Benefits of Annuity Payout Option

• Harder to go bankrupt: Since you have a payment coming in every year for 30 years, it makes it much harder to go bankrupt due to poor investment or financial choices.
• May allow you to pay less taxes: Depending on the size of the jackpot, electing to receive an annuity means 30 smaller payments. This allows for a portion of each payout to potentially be taxed at lower marginal tax rates and a lower tax burden.
• Ease into your new wealth: One of the hardest parts of winning the lotto is adjusting to your new level of wealth. Instead of a very large one time windfall, you get 30 smaller windfalls allowing you time to get accustomed to a new financial situation.
• Increasing Annuity: Each annual payment increases by 5%. This has the unintended benefit of behaving like a cost-of-living adjustment as inflation increases the cost of items.
• Death Benefit: If you die, the annuity passes on to your estate
• 30 years of income: Not only do you have a guaranteed cashflow stream, but you also get a built in protection from overspending as each payment is less than the lump sum.

Downsides of Annuity Payout

• Estate Planning: If you have the annuity payment and die leaving the remaining payments to your children. They may need to pay taxes on all undistributed installments. The current estate tax is 40% on values over $11.6 or $23.2 million for single/joint filers respectively. That means they may have more taxes due than cash available.
• Unknown Future Tax Rates: If you elect the annuity, you are at the mercy of tax law changes. If tax rates increase significantly, you would end up paying higher taxes on future payouts.
• Can’t undo decision if need money suddenly: If you need more money than scheduled, you can’t change your annuity. You would need to use a 3rd party structured settlement company or insurance company to purchase the remaining payments from you. This may be an expensive option.

The Final Word

Winning the lottery is life changing. And a big initial decision is whether to take the winnings as a lump sum or annuity.

In general, we disagree with the typical advice to take the lump sum. Even on the smallest jackpot of $40 million, you would get over $600,000 right away and $2.5 million at your last payment. That is likely way more than you make now. And by taking the annuity, you can avoid much of the ‘lotto winner’s curse’ of ending up broke a few years later. You have 30 years of payments and 30 chances to not make a mistake.

No matter what, if you win the lotto, the first thing you want to do is put together a team of trustworthy professionals to help guide you. A tax attorney, a financial advisor with fiduciary responsibility, a CPA, and an attorney who specializes in estate planning are a good start for this team.

Lastly, playing the lotto here and there with money you can lose is fine. Just make sure you aren’t spending money you can’t afford to lose or using the lottery as your retirement plan. You should learn personal finance and save ample money to ensure you are financially set.

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