Should You Take A Lump Sum Or Annuity If You Win The Lottery?
One of the biggest decisions lottery winners have to face immediately is whether to take their payouts as a lump sum or in installments, also known as an annuity. These questions also extend to those with pensions, but the question remains the same: All at once, or over time? There’s tax implications and the actual amount of money you receive will be different depending on how you are paid. Let’s look at pros and cons of each.
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Pros and Cons of a Lump Sum
The most obvious pro is access to all the money at once. There’s no waiting, no need to budget out how you will spend the few million allotted each month. It’s all there, ready for you to spend. If it’s not the Powerball, then you don’t run the risk of losing out on money you and your family could have earned.
If you invest properly – more on that later — it’s entirely possible to come out in the end with the same amount of money as if you took the annuity.
Despite also being under Pros, you have access to all of the money at once. This makes purchasing quite a few big-ticket items in quick succession a huge temptation. You can afford the mansion, the fancy car, and the boat, so why not?
The answer is simple: You’ll go broke. About 70 percent of lottery winners fall into this trap, spending their money without thinking much about it, not realizing there are taxes to pay on these items — remember that in most states, lottery winnings are taxed as income — and suddenly the money is gone. Even celebrities run into these problems.
The same is true for pensions. Improper investing could mean your pension is gone, and you have no money to see you through the rest of your retirement. Your options are limited in this case.
Lump sums are also taxed more than annuities. For example, in 2016, for the $1.5 Powerball lottery, a winning ticket – of which there could be three – would get $310 million each. Except the government immediately imposes a 25 percent tax, and come tax season, the IRS would take another 14.6 percent, for a total of 39.6 percent, or the same as the top income bracket. Suddenly, the $310 million is now $187.2 million per ticket. Still a lot of money, but not nearly as much as the winner might assume they would be getting.
Pros and Cons of an Annuity
There’s two big pros to an annuity, and both involve you getting to keep more money. First, annuities are taxed less than a lump sum, so over time, you will see more money in the bank.
Going back to 2016’s Powerball, the annuity would pay out yearly until 2045, despite the winner dying. For the first year, it’s a payout of $7.53 million. But, because annuities accrue interest to fight inflation, the last payment would be about $31 million. Note that the first payout is immediate, so the 30 payments are stretched over 29 years.
For pensions, the annuity does not run out until you die. This means guaranteed income for the duration of your life, though how much you earn can depend on how well the company you retired from is doing financially. This matters more if you have a large pension.
Second, because by their very nature you don’t get all the money immediately, you can’t spend it all quickly. You have to create a budget of sorts. Plus, if you do burn through your multi-million yearly payout, you can rest assured that, as long as you are alive and there are payments left, you will have money next year. Millions of dollars, to boot.
The major con is that you won’t receive all the money at once. Though, if you are able to spend the millions of dollars of your first payout within a year, it may be a good idea to take a look at your budget again, and perhaps make a visit to a financial planner to ensure you are still able to pay bills, as your credit could suffer otherwise.
There is one other con that applies to lotteries other than Powerball. While the Powerball winnings can be paid out in an annuity to family members should the winner die, other lotteries will simply stop payments. If the winner is older, the lump sum option may be the better choice.
For pensions, unlike lotteries, annuities are not adjusted for inflation or cost of living. It is a set amount. However, unlike lotteries, there is no time limit for payments — they keep going until death.
Finally, in either case, it’s a good idea to invest some of the winnings. It can be for multiple reasons — retirement, college funds for the kids, a trust fund for when they are older, or just leaving inheritance. There’s also investing in stocks to make money. It’s entirely possible to invest enough of lottery winnings smartly in order to live solely off of the dividends.
Those choosing a lump sum but making smart investments can still end up with the same amount of money as those choosing the annuity in this way. With installments, it allows for more spending than is possible with just the lottery payouts alone.
Whether you choose to take a lottery payout or pension as a lump sum or annuity depends on your situation. The goal in either case is to make the money go as far as possible without spending it all. Investing is an excellent way to make the most of your sudden windfall, with living off of just the dividends a possibility with smart investing.
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A former newspaper journalist, Cole spends his free time reading, writing, playing video games, watching movies, and learning about every subject under the sun. He lives with his wife and daughter in Idaho. Follow Cole on Twitter: @ColeMayer42
This post was updated December 6, 2017. It was originally published December 6, 2017.