Lottery Winners: Lump sum or payout over time?

[marting]

I was just watching a video where Mark Cuban (Shark Tank) said winners should take the long payout to avoid the risk of blowing it all.

A friend of my wife won the lottery over 2 decades ago. She was young and chose the 20 year payout. Still well over a million a year. She didn't let it affect her life. Finished college and went on to a teaching career where she met and became friends with my wife. Wife had no idea she was a lottery winner. One day when she was visiting it just came up in conversation about current events. Wife goes: "What?" She had assumed my wife had known or that she had told her long ago and was surprised my wife didn't know.

But it shows how one can live a fairly normal life and good for her. Especially at her young age at the time.

As an aside, the payout turned out to be by far the best decision. Interest rates were high at the time and a lump sum would have been far, far smaller. Interest rates decreased a lot over the next 20 years.

 

[Orphia Nay]

I'd just be worried the lottery company would go bust, taking my millions with it.

 

[gerdbonk]

I don't see how stretching an $8 payout over twenty years is going to be to my advantage.

 

[alfaniner]

(Considering at age say, 40). It would depend on how much. A million over 20 years would be a decent but steady (extra) income). A billion? So much more so.

But considering my current age and health issues, it would be practical to take the lump sum. Unless I found out the remainder could go to my estate -- then I'd take the 20-year option.

 

[Dr. Keith]

I was just watching a video where Mark Cuban (Shark Tank) said winners should take the long payout to avoid the risk of blowing it all.

A friend of my wife won the lottery over 2 decades ago. She was young and chose the 20 year payout. Still well over a million a year. She didn't let it affect her life. Finished college and went on to a teaching career where she met and became friends with my wife. Wife had no idea she was a lottery winner. One day when she was visiting it just came up in conversation about current events. Wife goes: "What?" She had assumed my wife had known or that she had told her long ago and was surprised my wife didn't know.

But it shows how one can live a fairly normal life and good for her. Especially at her young age at the time.

As an aside, the payout turned out to be by far the best decision. Interest rates were high at the time and a lump sum would have been far, far smaller. Interest rates decreased a lot over the next 20 years.

Rates are again high, so the long payout is a far better option today. When rates are low it is a tougher question.

 

[TragicMonkey]

Better to have control of your own money than be dependent on others' situation. Take the lump sum, invest it yourself.

 

[psionl0]

Two issues are the tax on your winnings and the net rate of return you could reasonably expect from a diversified investment portfolio.

 

[bobdroege7]

It's complicated, and depends on a number of factors.

But I would favor the long payout over the lump sum.

Though the smaller the jackpot the more likely to take the lump, say less than 5 million.

Or if my life expectancy was less than half of the payout term.

If I won the big one, the first thing would be to call my lawyer and hire an accountant.

 

[catsmate]

Invest the money you'd have wasted on the lottery.

 

[marting]

In the case of my wife's young friend, who was just starting college at the time, I think she wisely chose the long term payout and not letting it change her life's trajectory too much. Seems remarkable she went on to finish college and become a school teacher. I wouldn't have had the discipline. She did use some of the money to help her parents and gradually invested in the stock market and real estate.

While it was pure luck to take the long term payout when interest rates were about to start a long term decline, to me these were the standouts:

1. She didn't let it affect her life. Remarkable for someone 20 y/o.
2. She wasn't attacked by lots of grifters looking for handouts or offering "investments".
3. She was one of my wife's close friends for about a decade w/o my wife knowing.

As an aside, she rarely played the lottery. Just had some spare change after buying groceries and took a flier on what was left. She didn't find out until a friend mentioned she heard on the news a big winner had bought a ticket at a local store they both shopped at. Then looked up her ticket.

 

[Trebuchet]

At age 75, I'm taking the lump sum. Except I never buy a ticket.

 

[Andy_Ross]

Give me the lot.
If I blow it all then do be it.

It's not my job to ease the financial blow to the lottery company.

 

[Trebuchet]

The lottery company doesn't care. If you take the annual payout they just use the equivalent lump sum to buy an annuity from an insurance company. And since the lump sum probably amounts to less than 1% of what they took in....

 

[psionl0]

I guess it would make a difference which country you won the lottery in.

In Australia, there is no tax on "windfall gains" so it would make sense to take the lump sum (and invest it).

In the US, the tax on winnings from gambling is punitive so an annuity might be more logical.

 

[Babbylonian]

(Considering at age say, 40). It would depend on how much. A million over 20 years would be a decent but steady (extra) income). A billion? So much more so.

But considering my current age and health issues, it would be practical to take the lump sum. Unless I found out the remainder could go to my estate -- then I'd take the 20-year option.

Lottery annuities are like any other assets. So, yes, whatever winnings are left in the long-term annuity would be part of your estate upon death. If willed to one person the annuity could remain intact and simply continue paying yearly to the new recipient. Anything more complicated (including potential estate taxes) could require it to be cashed out for distribution.

 

[bruto]

At age 75, I'm taking the lump sum. Except I never buy a ticket.

Since I'm 75 too that would be my choice. Of course if I keep not buying tickets the choice becomes somewhat academic, though I am sure that would not stop a few of the more mystical thinkers on this site from making a list of the differences.

 

[TragicMonkey]

Two issues are the tax on your winnings and the net rate of return you could reasonably expect from a diversified investment portfolio.

You can't escape tax so don't bother trying, and if the sum is sufficiently large it doesn't even have to be diversified: you could dump a hundred million into extremely boring old T-bills that barely pay any interest at all and still live in fantastic luxury for several lifetimes.

 

[TragicMonkey]

2. She wasn't attacked by lots of grifters looking for handouts or offering "investments".
3. She was one of my wife's close friends for about a decade w/o my wife knowing.

That's wisdom for anybody with significant wealth, whether it's fantastical windfalls or just ordinary savings: don't let other people know you have money. It will only cause problems.

 

[psionl0]

You can't escape tax so don't bother trying, and if the sum is sufficiently large it doesn't even have to be diversified: you could dump a hundred million into extremely boring old T-bills that barely pay any interest at all and still live in fantastic luxury for several lifetimes.

Of course but I think you missed the point. An American who takes the lump sum not only pays a whopping great tax on the sum but they are taxed on any annuities it might generate. So taking just the annuity is one way of limiting your tax bill.

 

[TragicMonkey]

Of course but I think you missed the point. An American who takes the lump sum not only pays a whopping great tax on the sum but they are taxed on any annuities it might generate. So taking just the annuity is one way of limiting your tax bill.

Yeah, but "I'm tricking the tax man by having less money!" has never really struck me as a strategy worth pursuing. Like when managers try to convince their employees that not getting a raise is good "because you'll stay in a lower tax bracket".

 

[Chanakya]

I'd just be worried the lottery company would go bust, taking my millions with it.

This. You're tying yourself to the prospects of the lottery operator. An entirely avoidable risk, regardless of whether the money payout adds up to a bit more or a bit less, whether before tax or after. (Always provided you have the wits (or competent advice) to hedge your investment risks adequately. If not, and if you're going to invest in dicey schemes and projects, then maybe an already operational business like the lottery operator may be a better bet.)


(All of that provided you have the discipline not to splurge it all away. Apparently doing that is a thing, even with humongous payouts. Obviously, not getting to lay your hands on the money outright will help stem such impulses. ...Although not really, when you think about it, because if you're desperate enough to blow a ginormous fortune away, then you shouldn't find it difficult to find financiers who'll securitize your annuity for you, and advance you a discounted lump sum equivalent of your expected annual payouts. ...Still, opting for annuities might serve as a brake, even if not an insurmountable one. So if you believe you lack this discipline, then go for the annuity rather than the lumpsum, I guess.)

 

[Chanakya]

Of course but I think you missed the point. An American who takes the lump sum not only pays a whopping great tax on the sum but they are taxed on any annuities it might generate. So taking just the annuity is one way of limiting your tax bill.

Is that actually how it works, though?

(It might, it well might. I'm not saying otherwise. I don't know, one way or the other, how it works for lottery jackpots. If you actually know this, then I'm happy to take what you're saying at face value. Do you? Because if you're only guessing, then, well, given that corporates are sometimes taxed for future payments on accrual, then I'd imagine that something like a lottery win might well qualify, for accrual accounting I mean to say.)


eta: Nah, on second thoughts, not really. Because if you're going to be taxed for, say, 20 annual payments on accrual basis right in the first year itself, then your tax outgo in the first year will probably end up (far) exceeding what you take in in that year. If that were the case, then obviously the whole annuities thing wouldn't work at all, ever. Given that annuities are a thing, given that you're given a choice of this or that, that would have to mean that both choices are viable. Therefore, while I haven't looked up the accounting for this, but I guess you're right, it makes sense that you'll be taxed on receipt not accrual.

 

[marting]

Our friend's lottery payout was taxed on each, annual payout. However, there is no state tax here on lottery winnings so it was just federal tax.

Another issue is that large lottery winners are public by law in our state. Which makes it all the more remarkable that my wife had no idea about her friend.

 

[Trebuchet]

This. You're tying yourself to the prospects of the lottery operator.

As I said above, I'm quite certain the lottery operator purchase an annuity from a large insurance company.
If you get tired of the annuity, of course, there's always J.G.Wentworth. 877 CASH NOW!

 

[jadebox]

Yeah, but "I'm tricking the tax man by having less money!" has never really struck me as a strategy worth pursuing. Like when managers try to convince their employees that not getting a raise is good "because you'll stay in a lower tax bracket".

Sadly, a lot of people really do believe that they will pay a higher rate on all their income if they earn enough to get into a higher tax bracket.

 

[Vixen]

Wearing my accountant's hat I would say cash in your hand today is almost always better than cash in the future. Why? Because firstly, the future is uncertain. Secondly, the future holds inflation.

 

[Chanakya]

As I said above, I'm quite certain the lottery operator purchase an annuity from a large insurance company.
If you get tired of the annuity, of course, there's always J.G.Wentworth. 877 CASH NOW!

If that's the case, then sure, that risk's taken care of, agreed. It then boils down to your discipline and your investment savvy. Agreed, annuities might make sense for many in that case. If.

Wearing my accountant's hat I would say cash in your hand today is almost always better than cash in the future. Why? Because firstly, the future is uncertain. Secondly, the future holds inflation.

I don't know how this actually works. Maybe OP could tell us, how it was for his wife's friend.

I'd expect the annuity to include an interest component. But I don't actually know if it does. If it's a straight 100 translated into twenty payouts of 5 each, then agreed, it would be silly to even consider that option. Because inflation, and also because opportunity cost. This would be a textbook school level discounting question. Absolutely, it would be absurd then, if the annuity option doesn't factor in some growth.

 

[psionl0]

Yeah, but "I'm tricking the tax man by having less money!" has never really struck me as a strategy worth pursuing.

Who is talking about "tricking the tax man"? Obviously, you would need to question your tax accountant on lump sum vs annuity especially since there may be tax rules specifically designed to stop you but otherwise, choosing an annuity to defer your tax bill (and possibly lower it) is perfectly legitimate.

Like when managers try to convince their employees that not getting a raise is good "because you'll stay in a lower tax bracket".

Does that have anything to do with tax on your winnings at all?

 

[shemp]

TAKE THE CASH!

 

[The_Animus]

Take the lump sum, invest it in an index fund, and each year take out: total value * (1/remaining life expectancy) or less if you find you don't need it that year.

 

[NewtonTrino]

You take the lump sum.

When someone else holds your money it is at risk. It's not just risk that the entity is poorly run or that the entity lacks proper insurance. You are taking inflationary risk, you are paying opportunity cost of not having cash on hand. Any tax savings are theoretical at best as you don't know future tax rates.

Mark Cubans advice is basically given based on the fact that joe average is a financial moron. Even taking the payout over time doesn't protect you from spending the money. You can borrow against that income stream and get yourself into trouble just as easily.

I think most people might be surprised at how little money a million dollars is if you want to live a fancy lifestyle.

 

[bruto]

Wearing my accountant's hat I would say cash in your hand today is almost always better than cash in the future. Why? Because firstly, the future is uncertain. Secondly, the future holds inflation.

I tend to agree with that. In addition at least in my case, being 75 and having numerous beneficiaries looming, I think an annuity would be complicated.

And as TM points out too, if the amount is large, it's likely large enough. We have to keep some perspective here. If you won a measly million bucks (measly in the context of some of those big lottery wins) you could, after all, stuff it in your mattress and spend 50 thousand of it a year for the next 20 years!

 

[marting]

I tend to agree with that. In addition at least in my case, being 75 and having numerous beneficiaries looming, I think an annuity would be complicated.

And as TM points out too, if the amount is large, it's likely large enough. We have to keep some perspective here. If you won a measly million bucks (measly in the context of some of those big lottery wins) you could, after all, stuff it in your mattress and spend 50 thousand of it a year for the next 20 years!

It can be complicated as you get older. There's a stepped up basis on death so taxes on the inherited annuity go to zero but if the present value of the annuity is higher than the exclusion (10-20m), there is an inheritance tax that eats into it more than income taxes would. Breakeven might be 50m or so. But for smaller amounts the annuity would result in significantly lower taxes.

Our friend's case was different. She was young so the tax issue was that there was some benefit from the brackets so her net taxes would have been around 33% v 37% taking the lump sum.

Probably the main "benefit" is that a really large chunk all at once might have been tempting to spend or make unwise investments. Spread out over time it gave her a chance to see how her earlier investments panned out and develop a more intuitive sense of what to do with what, in any case, was pretty large annual payments.

In any case she spent and invested wisely.

 

[bruto]

It can be complicated as you get older. There's a stepped up basis on death so taxes on the inherited annuity go to zero but if the present value of the annuity is higher than the exclusion (10-20m), there is an inheritance tax that eats into it more than income taxes would. Breakeven might be 50m or so. But for smaller amounts the annuity would result in significantly lower taxes.

Our friend's case was different. She was young so the tax issue was that there was some benefit from the brackets so her net taxes would have been around 33% v 37% taking the lump sum.

Probably the main "benefit" is that a really large chunk all at once might have been tempting to spend or make unwise investments. Spread out over time it gave her a chance to see how her earlier investments panned out and develop a more intuitive sense of what to do with what, in any case, was pretty large annual payments.

In any case she spent and invested wisely.

Yes, I think if I were much younger and got a big win, I'd take it in an annuity. It would reduce the temptation to blow it all at once, and also the ability of others to get at it, and would allow one to relax for a long time with a little added security.

 

[TragicMonkey]

You take the lump sum.

When someone else holds your money it is at risk. It's not just risk that the entity is poorly run or that the entity lacks proper insurance. You are taking inflationary risk, you are paying opportunity cost of not having cash on hand. Any tax savings are theoretical at best as you don't know future tax rates.

Mark Cubans advice is basically given based on the fact that joe average is a financial moron. Even taking the payout over time doesn't protect you from spending the money. You can borrow against that income stream and get yourself into trouble just as easily.

Or to phrase it as the original ancient wisdom: a bird in the hand is worth two in the bush. Either Deuteronomy or Aristotle, I forget which.

 

[bruto]

The lump sum argument is a compelling one too, but I think it depends on circumstances. If, for example, you know you have some mooching relatives or other circumstances that might cause you to mess up, then the annuity could be safer. Of course if you're smart and a good investor, you probably do better with the lump sum. The other part of the annuity issue may depend on what the agency is, and when this happened. If you won a big state jackpot years ago, it's clear that the states have not gone bankrupt and forfeited on their obligations. If I won today, I'd have second thoughts about the honesty and shape of any government down the road.

So yeah, I can still see some of the attraction of the annuity, since it's quite predictable, and in some degree market proof as well. But I'd probably go for the lump even if I were younger.

It's fun to imagine all the different ways one could manage the fortune you'll never get. Saves the cost of the ticket too.

 

[TragicMonkey]

The lump sum argument is a compelling one too, but I think it depends on circumstances. If, for example, you know you have some mooching relatives

"Cousin Becky, darling, sweetie, I fear I cannot at this time give you three hundred thousand dollars for your art school debt. I can, however, put aside thirty thousand dollars for a professional hitman."


eta: I hasten to add the above was just a joke, I would never hire a hitman for $30,000 to kill Cousin Becky. She lives in a trailer park in rural Oklahoma, I could get someone to do it for two ounces of meth.

 

[Puppycow]

A friend of my wife won the lottery over 2 decades ago. She was young and chose the 20 year payout.

I think it very much depends on your age, but the people who choose the 20 year payout are probably also the people who are least likely to blow it all in 3 to 5 years and end up broke again.

Anyone under age 50 and in decent health should probably take the payment plan whereas for older people it may depend on your particular circumstances, state of health and so on.

 

[Puppycow]

You take the lump sum.

When someone else holds your money it is at risk. It's not just risk that the entity is poorly run or that the entity lacks proper insurance. You are taking inflationary risk, you are paying opportunity cost of not having cash on hand. Any tax savings are theoretical at best as you don't know future tax rates.

Mark Cubans advice is basically given based on the fact that joe average is a financial moron. Even taking the payout over time doesn't protect you from spending the money. You can borrow against that income stream and get yourself into trouble just as easily.

I think most people might be surprised at how little money a million dollars is if you want to live a fancy lifestyle.

Maybe you're right, but I want to see the actual math.

For example, if you invest your money in anything, literally anything, you are also taking a risk, right? Generally, someone else holds your money when you invest it. Lotteries in the US are usually sponsored by state governments and I don't think I've ever heard of them stiffing a lottery winner.

If it's equivalent to, say, earning 8% interest on investment income per year, essentially risk-free, it seems like a no-brainer to me compared to say, investing in an index fund that is not guaranteed to only go up in value over time.

I also agree that it's probably a good idea to not try to live a fancy lifestyle, but that's a separate question.

 

[psionl0]

You take the lump sum.

When someone else holds your money it is at risk. It's not just risk that the entity is poorly run or that the entity lacks proper insurance. You are taking inflationary risk, you are paying opportunity cost of not having cash on hand. Any tax savings are theoretical at best as you don't know future tax rates.

Mark Cubans advice is basically given based on the fact that joe average is a financial moron. Even taking the payout over time doesn't protect you from spending the money. You can borrow against that income stream and get yourself into trouble just as easily.

I think most people might be surprised at how little money a million dollars is if you want to live a fancy lifestyle.

Leaving aside the fact that any way you invest the lump sum will also have its risks, I don't see the advantage of taking the lump sum. You will be heavily taxed on the lump sum meaning that any returns from the remains that you have invested will be smaller and you will be taxed on these returns as well.