Winning the lottery is an incredibly exciting event that can change your life. One of the most important decisions you’ll make as a lottery winner is whether to take the winnings as a lump sum payment upfront or as an annuity paid out over many years. There are advantages and disadvantages to both options, so it’s important to carefully weigh your choices. This article provides an in-depth look at the lump sum versus annuity decision to help you make the best choice for your situation.
What is a lottery annuity?
With an annuity payout, you receive your lottery winnings spread out in incremental payments over many years, typically 20 or 30 years. The lottery company invests your money and then uses the interest earned to pay out your annual lottery payments. Each year, you receive a portion of the total winnings. For example, with a $10 million prize and a 30-year annuity, you would get annual payments of about $330,000 per year for the full 30 years.
Annuities provide financial security by ensuring steady income for life. You don’t have to worry about managing a large lump sum or running out of money. The payments are guaranteed by the lottery commission, and you’ll continue receiving checks even if the lottery company goes out of business. Annuities also protect you against overspending. You can’t blow all the money at once since it arrives in smaller chunks over time.
What is a lump sum lottery payout?
With the lump sum option, you get the entire lottery prize all at once in a single payment. So for a $10 million jackpot, you would get the full $10 million right away (minus taxes withheld). You then have complete control over the money and can use it however you want – investing, paying off debts, buying a house, donating to charity, etc. The flexibility of a lump sum is appealing since you get immediate access to the full amount.
However, the risks are also greater with a lump sum. You’re responsible for managing the money and making it last. You could make poor investment choices and lose the money. Or you might spend lavishly and blow through the cash within just a few years. Sudden wealth can be challenging without professional help. Lump sums also typically receive a lower payout. Lotteries discount lump sum payouts, while annuities pay the full advertised jackpot.
How do lotteries calculate lump sums?
Lotteries use a discounted cash flow analysis to calculate lump sum amounts. This evaluation considers future interest rates and the time value of money. Basically, the lottery figures out how much upfront cash it would take to generate the same earnings as the total annuity payments over 20 or 30 years when invested. This amount is always lower than the announced jackpot.
For example, let’s say the advertised annuity prize is $360 million paid out over 30 years. Given current interest rates and other financial factors, the lottery might calculate the cash value at $200 million. This becomes the lump sum amount. You get all the cash upfront, but the total is reduced by 45% compared to the annuity. However, you then have flexibility in investing and spending the money as you want.
Should I take the lump sum or annuity?
Deciding between the lump sum and annuity depends mainly on your financial personality and circumstances. Here are some key factors to consider:
Interest rates
If current interest rates are high, the lump sum amount will be closer to the annuity total. That’s because the lottery can generate more investment income from the lump sum. When rates are low, the lump sum is reduced further compared to the annuity.
Investment opportunities
Lump sums allow you to invest the winnings and potentially generate higher returns than the annuity. If you have sound investment plans, you may come out ahead with a lump sum. Of course, higher returns aren’t guaranteed.
Life expectancy
If you live long enough, an annuity ends up paying more overall compared to a lump sum. But if you have health issues or a family history of shorter lifespans, the lump sum can be a better option to access money now.
Taxes
Annuity payments spread out taxation over many years compared to the lump sum which can push you into higher tax brackets immediately. But annuities aren’t entirely tax-free either. You owe taxes on the portion of each payment considered interest.
Spending habits
If you have trouble controlling spending, an annuity provides built-in protection against overspending. But if you’re disciplined and savvy with money, a lump sum gives maximum flexibility.
Here’s a comparison table of lump sum versus annuity pros and cons:
| Lump sum pros | Lump sum cons | Annuity pros | Annuity cons |
|---|---|---|---|
| – Full amount available immediately – Investments and growth opportunities – Flexibility in spending – Can leave remaining money to heirs |
– Lower payout (discounted amount) – No guarantees or protections – Risk of reckless spending – Complex tax implications |
– Guaranteed income for life – Payments protected from creditors – Less tax burden over time – Steady payments to manage – No investment responsibilities |
– No flexibility or control – Lower return than investments – Lose utility of full amount – Less money for heirs |
How have other winners chosen?
Looking at choices made by past lottery winners can provide additional insight into the lump sum versus annuity decision:
Powerball winners who took annuities
- The $1.5 billion 2016 Powerball winners in California, Florida, and Tennessee all opted for annuities.
- Mavis Wanczyk chose a $25 million annuity after winning a $758 million Powerball jackpot in 2017.
- A New Hampshire woman remained anonymous after her $560 million Powerball win but also went with the annuity.
Powerball winners who took lump sums
- The winners of a $632.6 million Powerball jackpot in 2015 took lump sums of $108 million each (out of $327.8 million).
- A Vermont man took a lump sum payment of $88 million after winning a Powerball prize of $316.3 million in 2014.
- Powerball’s biggest single winner of a $590.5 million jackpot in 2013 chose a $370 million lump sum.
For giant jackpots, most winners stick with annuities to get the full amount and protect against overspending. Smaller lump sums under $100 million or $200 million are more popular. Taxes eat up a significant chunk, but the remaining cash allows flexibility.
Annuity and lump sum choices also depend on the number of winners. Single ticket winners are more likely to choose cash. Groups opt for annuities to carefully manage multiple payments.
What are the tax implications?
Taxes make a significant difference in the final amounts received for lump sum versus annuity payments. State and federal taxes apply to both options.
Lump sum taxes
A 25-39.6% federal tax rate applies to lottery lump sums above $600,000, along with possible state income taxes from 5-8%. Lower rates apply to winnings under $600,000. For example, a $500 million advertised jackpot with a $300 million lump sum payout would face $150-$200 million in combined taxes. You only get to keep about half the lump sum.
Annuity taxes
Annuity taxes are taken out of each annual payment. Only the portion considered interest income is taxed, not the principal amount. For example, with a $10 million annuity invested at 5% interest over 30 years, about $165,000 of a $330,000 annual payment would face taxes. Annuities average around 30% lifetime tax liability versus 40-50% taxes on large lump sums.
Here’s a table comparing estimated taxes on a hypothetical $10 million lottery prize:
| Payout method | Pre-tax payout | Estimated taxes | After-tax amount |
|---|---|---|---|
| Lump sum | $10 million | $4-5 million | $5-6 million |
| Annuity | $10 million ($330,000 x 30 years) | $3 million over 30 years | $7 million over 30 years |
Taxes make a huge difference. An annuity results in about $1-2 million more income after taxes compared to the lump sum for a $10 million prize.
Can I change my mind after choosing?
Most lotteries require you to make a binding decision between annuity and lump sum when claiming the prize. It’s extremely difficult or impossible to revert your choice after the fact. A few exceptions do exist:
- If multiple winners must agree on annuity or lump sum, one winner can file a lawsuit to force a change later.
- A judge may allow swapping annuity and lump sum in the event of an emergency or financial hardship situation.
- Some private entities that offer annuity-type lottery payouts allow owners to change between installments and lump sum.
But in general, lottery winners can’t change their mind. The decision is locked in once made, so choose carefully upfront.
Can I take a partial lump sum?
Most lotteries also don’t allow partial lump sums – it’s typically all or nothing. You can’t take a lump sum of 25% or 50% and keep the remaining payments as an annuity. But again, some exceptions exist:
- Certain “private” lotteries allow winners to take a portion of their winnings as a lump sum upfront and assign the remaining payments to an annuity.
- A few state lotteries like Pennsylvania allow partial lump sums at a reduced rate when renewing annuity payments.
- Annuity holders can sometimes sell off a portion of remaining payments for a lump sum via settlement companies.
But otherwise, lottery winners usually must choose one payment method or the other.
Can I leave annuity payments to heirs?
Annuity jackpots don’t transfer to heirs by default when you die. Any remaining payments revert back to the lottery commission. However, some ways exist to pass on lottery wealth to children or other beneficiaries:
- Buy an annuity settlement that names a beneficiary to take over payments when you die.
- Place remaining payments into a lottery trust or estate.
- Convert to a lump sum later and leave the cash inheritance in a will.
With proper planning, you can ensure some of your annuity jackpot goes to heirs. But it’s more complicated than directly leaving them a lump sum inheritance.
Should I get financial advice?
Consulting financial experts is highly recommended before claiming a large lottery prize. Advisers can help analyze your situation and determine if a lump sum or annuity better meets your needs. Key professionals include:
- Accountants – Analyze tax implications of different options.
- Investment managers – Determine best strategies for investing lump sum.
- Lawyers – Provide estate planning and trust creation services.
- Insurance agents – Help arrange annuities and structured settlements.
Financial experts charge fees but can help maximize your winnings. Don’t make annuity versus lump sum decisions alone.
Beware of adviser scams
Unfortunately, shady financial advisers sometimes try to take advantage of lottery winners through excessive fees, commission scams, and ill-advised investments. Tips to find legitimate advisors include:
- Check credentials and complaints histories with regulators.
- Interview multiple established local firms, not just individuals.
- Require transparency on all fees and commissions upfront.
- Review credentials of individual employees who will manage your money.
- Start with a smaller account while vetting advisers over time.
Take your time to carefully screen financial firms and advisers before handing over lump sum winnings.
What other factors affect my choice?
A few additional considerations can help guide your lump sum versus annuity decision:
Age and health
Younger, healthy lottery winners may favor annuities to ensure steady income through retirement. Those with health issues may want lump sums to access money sooner.
Other income
If you have sufficient income from other sources, a lump sum provides more flexibility. Annuities make sense for those relying on lottery payments as primary income.
Debts
Lump sums allow you to immediately pay off debts like mortgages, student loans, etc. Annuities slowly pay down debts over time.
Family situation
Married couples may prefer annuities to provide ongoing support to a surviving spouse after one partner dies. Young families can benefit from annuities to fund college savings as kids grow up.
Sudden wealth risks
Research shows most lottery winners eventually go bankrupt after “sudden wealth syndrome” resulting from reckless overspending of lump sums. Annuities protect against this risk.
Conclusion
The choice between lump sum or annuity lottery payouts involves weighing many personal factors. Annuities provide guaranteed income for life but less flexibility. Lump sums generate higher returns through investing but require financial discipline. There’s no single right answer – it depends on your money personality. Many financial experts recommend annuities for these reasons:
- You want to maintain the same lifestyle indefinitely without budgeting or money stresses.
- You aren’t experienced or comfortable managing large investments.
- You worry about reckless spending or giving away too much money.
- You want to maximize account balances for heirs after you die.
Lump sums tend to work better when:
- You have strong investment skills and experience to grow the money.
- You have modest current wealth and can benefit from a sudden increase.
- You have specific large purchases or debts to pay off.
- You want flexibility in charitable donations and family gifts.
Every situation is unique. Weigh all the factors carefully and get professional advice before deciding. With proper planning, either lump sum or annuity lottery winnings can provide financial security for life.