Should you be lucky enough to win the grand prize in a major lottery, you will have an important decision to make beyond which car or mansion to buy. Before you can see a dime of those millions, you have to decide whether you wish to receive a one-time payment or get annual payments for many years to come. This is a critical choice, since you can't change your mind once you sign on the dotted line.
Say your state lottery announces that the jackpot for the upcoming drawing is a mind-blowing $500 million, and you're the sole winner. Well, even under this extremely unlikely scenario, you aren't entitled to an immediate payment of $500 million. You'll only get that much money in total, before taxes, if you elect to receive the sum in yearly payments over many years to come. Should you elect to receive cash all at once, you will receive less.
In the case of New York State's Mega Millions in March 2012, for example, the lump-sum payment for a $500 million jackpot was a little under $360 million. The annual payments, on the other hand, were $19,250,000 a year over 26 years, adding up to $500 million.
Keep in mind, too, that whether you elect to receive a lump sum or spread the income over many years to come, the state will withhold a significant amount of tax. At least 25 percent is withheld for federal taxes, and your state taxman will also take his cut, of course.
If you are lucky enough to win a jackpot in the millions, total taxes you'll pay will likely be the same whether you take a lump sum or annual payments. Even a million every year puts you in the uppermost tax bracket and results in the same percentage tax rate as taking several hundred million all at once.
The annual payment rates are calculated based on the prevailing interest rates. In the case of Mega Millions, for example, the annual payments were set at $19,250,000 because taking in the lump sum of $360 million and depositing it into your local bank would allow you to withdraw an average of $19,250,000 per year for 26 years when you take interest income (at the current interest rate) into account. So, from a purely financial viewpoint, the two paths are equally viable. The lump sum makes more sense, however, if you think that tax rates will go up over the coming years. In that case, you're better off paying taxes right away at the presently lower tax rate.
Benefits of Annuity
Keep in mind that many lottery winners squander their winnings in a short period of time or are taken advantage of. Should you make a few silly mistakes over the first few years, you would still have more than two decades of a multi-million-dollar annual paycheck. That is a lot of time to wise up and make better choices with your newfound wealth. Before you elect one of these options, talk to a qualified financial consultant as well as a lawyer — and best of luck in the next drawing.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.