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Lottery Winners: Lump sum or payout over time?

Before I finally start to "do my research" in Google, couple of anecdotes.

I personally know of two lottery winners among the people I personally know, and as chance would have it, they were employee and employer of one another, respectively.

The first to win a large-ish lottery price was the employee. I know this story only second hand, and it happened when I was a little kid, so I can't actually vouch for its truth value.
He and his wife played a lottery weekly together with friends, a lottery pool. I don't know, if we are talking two couples, or four or what... Anyway, they didn't even win the main prize, they only won the 2nd class prize, which would have been something like 50,000 Deutsche Mark, order of magnitude. Surely, that was nice money in the early 1970s, but nothing to live a high life on.
Regardless, the dude and his wife thought they were rich now - and he quit his job!
A year or two later, he came back, begging for his old job, because the money was gone. He got it back and kept it till retirement.

A decade or two later, his employer won the big price. Well, big-ish. Probably something like 3 million Deutsche Mark. Now that, in the 1980s, probably was money that could see a man and his family through, if invested wisely.
It was not invested wisely.
For starters, he built a house. It was far too big, too fancy, as he forgot that by the time the house was finished, the children would have moved out or be close to moving out.
But worse than that was probably that the windfall came just in time to prevent his business from going bankrupt. Being a nice, socially responsible boss, and perhaps not the greatest business man in the world, he didn't lay off anyone, kept making losses, and essentially gave lots of the money away to his employees.
And bought two or three cars too many.
And then he died.
His wife and children then discovered that he had stuffed a good part of what was left of the cash in nameless bank accounts in Luxemburg or Switzerland or whatever, had forgotten to tell the taxman about it... And so the money was off-limits to the heirs, unless they outed the tax fraud and payed several years of avoided taxes, plus interest.

------------

So. That's my personal database. Sample of 2, I know. Generally in line with the meme that not few lottery winners fly off into lala land.
 
Here's an interesting paper on the impact v work centrality v smount of winnings. For most people with large winnings, they quit work but for smaller winnings ( < 10M) it varied and depended on multiple factors but much fewer quit work.

https://www.researchgate.net/public...d_Post-Award_Work_Behavior_of_Lottery_Winners

Doesn't apply to our friend who was just starting grad school. But good for her she didn't let it screw up a normal life. Probably more the exception than the rule as just under 1M/y after taxes for 20 years would screw up many of us. Me included.
 
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Aaaand here is the first decent dataset that I found (Googling in German) - tjis is about the Swiss state lottery, as reported by Swiss public broadcaster SRF, from early 2020:
https://www.srf.ch/news/schweiz/50-jahre-zahlenlotto-so-vernuenftig-sind-schweizer-lotto-millionaere

This Swiss lottery had been around for 50 years then (the anniversary is the occasion for the article), and since 1979, when the first win >1 million occurred, had produced 769 millionaires in Swiss Francs. That's about 19 per year on average in the years 1979 - 2019. I would assume that both ticket prices and winning payouts have increased over time, such that there will be certainly more than 20 millionaires annually.

The article says that they started in 2016 to inquire with lottery winners of 5 years ago how they are doing today.

The result, generally speaking: Most have behaved responsibly, are still rich, not much has changed.

For example, take the question "Do you still profit from your win?". They asked 73 winners of the years 2011 through 2013
68 responded.
Of these, only 1 reported that not much of the money is left.
About half the winners by the way moved to a different place - many probably to lower their tax burden! (Tax rates can vary greatly from canton to canton within Switzerland)

The question whether the windfall affected social relationships was affirmed by only 6 persons; one did not respond, 66 say that relationships are unaffected. Most of these apparently have kept their luck a secret shared with only a small circle of closest family and friends.

Question: Did you purchase luxury items yet?
A majority self-reports to essentially limit themselves to only a somewhat increased level of comfort - eat out more expensively than before, buy a new car earlier than planned, beef up vacation itineraries - so nothing outrageous or new. Only about a third reported extraordinary expenses.

----------------

This is a small dataset; it relies on self-reporting; the categories may not be very well defined; and the Swiss, a famously rich nation that has "Banking" in its DNA, may not be representative for lottery winners everywhere. I suspect they could not contact all winners, and those they failed to reach may be skewed towards less responsible behaviour (perhaps felt adventurous and left the country...).

Still interesting. And surely not in line with my personal intuition.

(The Swisslos lottery only pays out a lump sum, no payment plans are available)
 
For starters: 20 * 750,000 = 15 million.
That's 5 million less than the lump sum you propose.
Doesn't make an aweful lot of sense, does it? At least I don't get it.
The future value of 20 * 750,000 is 20,000,000 if you assume a discount (interest) rate of 3%.

In a simpler example, 20,000,000 will generate an income of 600,000 in perpetuity if invested at 3%.

But maybe I should have used the NPV of the annuity since you have the option of taking the 20,000,000 now instead of in 20 years time. This would make the annuity $ 1,305,159 and a lot more attractive than investing 10,000,000.

Incidentally, if offered a choice between a lump sum and an annuity, you should work out what discount rate they are using.
 
I just discovered that my single Mega Millions ticket from last night won $2. I have decided to take the lump sum.
 
Let me add a little here. First off, if you want to spend the money right now then the answer is pretty obvious. Second, I’ll just speak to the really big government-run, American lotteries. Conditions may be different for others.

I’ll assume here that one really is after a lifetime income and ask which is the best way to do it.

If you take a lump sum, you pay income tax up front. For a large win that’s somewhere between a third and probably 40+ percent off the top! You then invest the remainder and live off the proceeds.

Alternatively, the government invests the entire lump sum and pays out the proceeds over 30 years.

So how big is the lump sum you get if you take the lump sum option? It’s exactly the amount the government needs to invest to make the payouts!

So if you take the lump sum and make the same investments the government makes, you are worse off by the third+ that you had to give up upfront.

If you think you can invest more wisely than the government…well then, maybe that’s also why you by lottery tickets.

What is true though is that you might be willing to invest differently because you are willing to take more risks. If you put the money in stocks, the odds are you would get a higher return than the government (although you still have to overcome that huge loss from taxes upfront). But you would be taking a chance of losing your money, where the government only invests in safe assets.

This is why the usual financial advice is to take the annuity.
 
[q]I’ll assume here that one really is after a lifetime income and ask which is the best way to do it.[/q]

I actually don't think this is all that great of an assumption. Too many people in too many different circumstances.

Anyway you can't work out the numbers because you don't know what future tax rates will be which is a massive potential X factor. Personally I would rather have the cash in hand than have it be spread out over a zillion years.
 
I get that but we are speculating in the dark. We need some data. Since we don't have any, let's make some up.

Suppose that you have the choice between $20,000,000 lump sum or $750,000 per year for 20 years.
.....

That works for a lottery win where the lump sum payout is at the end of 20 years. Pretty sure no one would take a lump sum payout if they had to wait 20 years. Lump sums are typically paid in a month or two after winning using NPV of a series. I think that is why Oystein found the numbers strange.
 
QUOTE=NewtonTrino;14156252][q]I’ll assume here that one really is after a lifetime income and ask which is the best way to do it.[/q]

I actually don't think this is all that great of an assumption. Too many people in too many different circumstances.

Anyway you can't work out the numbers because you don't know what future tax rates will be which is a massive potential X factor. Personally I would rather have the cash in hand than have it be spread out over a zillion years.[/QUOTE]

Sure, if you want to spend the money soon, then you need to get it soon.

I agree that if tax rates go up in the future you might be better off taking the lump sum and paying taxes on the principle at the current rate. But given the huge bite on the lump sum (in the U.S.) they’d have to go way up for that to change the decision.

In addition, if you take the lump sum you may be taxed at a higher rate in a progressive tax system such as in the United States. (Unless you win such a big pot that everything is at the maximum rate. That’s what I’m planning on winning.)
 
Let me add a little here. First off, if you want to spend the money right now then the answer is pretty obvious. Second, I’ll just speak to the really big government-run, American lotteries. Conditions may be different for others.

I’ll assume here that one really is after a lifetime income and ask which is the best way to do it.

If you take a lump sum, you pay income tax up front. For a large win that’s somewhere between a third and probably 40+ percent off the top! You then invest the remainder and live off the proceeds.

Alternatively, the government invests the entire lump sum and pays out the proceeds over 30 years.

So how big is the lump sum you get if you take the lump sum option? It’s exactly the amount the government needs to invest to make the payouts!

So if you take the lump sum and make the same investments the government makes, you are worse off by the third+ that you had to give up upfront.

If you think you can invest more wisely than the government…well then, maybe that’s also why you by lottery tickets.

What is true though is that you might be willing to invest differently because you are willing to take more risks. If you put the money in stocks, the odds are you would get a higher return than the government (although you still have to overcome that huge loss from taxes upfront). But you would be taking a chance of losing your money, where the government only invests in safe assets.

This is why the usual financial advice is to take the annuity.

I get it, more or less, but still wonder:

We stipulate that the lump sum is equal to the sum which the government will use for the annuity. So let us imagine you invest it with the intention of trying to beat the government. You start, essentially, with the same amount the government does. The race is on.

That would indicate that if you invested exactly as the government does, you'd end up with the same income over the lifetime of the annuity. Except we presume that whatever vehicles the government invests in, it does not pay any tax. It passes all the tax to the beneficiary, and (as far as I know) it is in the form of regular income, no matter where the government got it. I am also assuming that the annuity pays out a specified amount, so if the government does not invest well, they eat the difference, and if they do better, they keep the difference.

So if you took the lump sum with the intention of trying to better the return over that of the annuity, you'd appear to have several choices

One is that you don't equal the government, for various reasons, not always your fault. Maybe worse investments, maybe taxation. Score one for the annuity. If the economy is bad and investment goes poorly the annuity wins. If the amount of the lump sum is accurately predicted to provide the required annuity using investment advantages you don't have, your lump sum may not have the same investment power as the government's, so the annuity probably wins. If you misidentify your risk and lose a big hunk or all of your lump sum, of course the annuity wins. I presume the annuity is the safer choice.

Two is that you invest better, and get more, both before and after tax. This would be especially true if the investment opportunities are better than predicted, since you get it all. Score one for the lump sum.

Three is that you invest differently, and despite ups and downs owing to long term holding, etc., but benefiting from taxation differences, shelters, loopholes, etc. , and perhaps also to a tolerance for risk, you net more after tax. Score one for the lump sum.

Four is of course that you equal, or approximately equal, the government return. I you do it yourself, you get more opportunity but also more risk. If you hand it to the government, you get to relax and let someone else do the lifting. I'd rate that as a tossup, depending on numerous factors of prize size, beneficiary age, need, and so on.
 
I think you’ve outlined the possibilities nicely…with one exception…

I get it, more or less, but still wonder:

We stipulate that the lump sum is equal to the sum which the government will use for the annuity. So let us imagine you invest it with the intention of trying to beat the government. You start, essentially, with the same amount the government does. The race is on.

That would indicate that if you invested exactly as the government does, you'd end up with the same income over the lifetime of the annuity.

The problem is that the government gets to invest the entire lump soon. You or I lose a third or so of it to taxes before we start investing.
 
I think you’ve outlined the possibilities nicely…with one exception…



The problem is that the government gets to invest the entire lump soon. You or I lose a third or so of it to taxes before we start investing.

Point taken. I was assuming from the way you put it that the government, in anticipation of the investment needed, is starting with a sum equivalent to the post-tax lump sum, but I don't suppose there's any law that they have to. They could, presumably, allocate the entire amount, treating it as borrowed money and keeping the profit. Or for that matter, I don't know how they do it, and there might be some overall lottery fund that handles all the investment for all payouts all at once, without fine division. Thinking about it, that last possibility makes a lot of sense, and would give the state considerable buying power for large investments, as well as some added flexibility, and I'd be surprised if they don't do it that way.

Thought of this way, the case for the annuity gets a boost, as the likelihood of the first scenario becomes greater. Though I still think it comes down at least in part to a question of the relative importance of opportunity and control, and that in turn depends some on the size of the prize and an individual's needs.

For example, in my case, being 75, having enough to live well on already, and a few heirs, I'd almost certainly take the lump sum, feel a little richer, and plan to divide it up between heirs and favorite charities. When I was younger, the economy was a little different, and I might still have opted for the lump sum as a source of opportunity, but it might not be the same now. If I look back, for example, to 50 years ago, I can say with certainty that investment made back then would win the race. The house I bought in 1975 quadrupled in value in 13 years, for example. Other small investments have burgeoned. But that may not be the case now, and of course if the annuity income had exceeded my needs, I could have invested that surplus with similar results. So in the end it really comes down to a gamble on both one's own future and that of the economy.
 
That works for a lottery win where the lump sum payout is at the end of 20 years. Pretty sure no one would take a lump sum payout if they had to wait 20 years. Lump sums are typically paid in a month or two after winning using NPV of a series. I think that is why Oystein found the numbers strange.
It's a pity that you didn't read the rest of my post. :(
 
It's a pity that you didn't read the rest of my post. :(

The next part of your post affirms the 20M lump sum.

Suppose that you have the choice between $20,000,000 lump sum or $750,000 per year for 20 years. And suppose that the tax on each is 50%. Then taking the first option, you would get $10,000,000 in hand which you decide to invest.
 
The annuity. It's a complete no-brainer, given that the lump sum is heavily discounted. You won't beat those returns on the stock market.

Then again, you also won't win the lottery.
 
The annuity. It's a complete no-brainer, given that the lump sum is heavily discounted. You won't beat those returns on the stock market.

Then again, you also won't win the lottery.

I guess it depends on what you see as the best use of money is. Maximizing how much money you end up with in the end seems like an odd thing to prioritize.

One of the whole points of being fabulously wealthy is that you have to worry less about maximizing the value of every last cent.

To state the obvious, the practical value of your fortune drops to $0 when you die. Leaving behind a inheritance is nice I suppose, but surely that's not the primary factor when it comes to wealth management. That's not to say you should blow through the entire thing in your lifetime, but it's also pointing out that maximizing your returns is not really the the only consideration.

The difference say between $100 million or $102 million over 20 years doesn't seem significant enough to seriously steer a decision. The diminishing marginal utility of money means that these are both basically the same number, unless you're donating your money to those that haven't reach the asymptotic part of this graph.
 
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I guess it depends on what you see as the best use of money is. Maximizing how much money you end up with in the end seems like an odd thing to prioritize.
Is there a better way to answer the question than to think about the relative value of the options? We're not talking about a major commitment of time or energy here. Just take the less stupid option.

To state the obvious, the practical value of your fortune drops to $0 when you die. Leaving behind a inheritance is nice I suppose, but surely that's not the primary factor when it comes to wealth management.
To the very rich, estate planning is a major consideration in wealth management, precisely because you'll have trouble spending that much in one lifetime.

The difference say between $100 million or $102 million over 20 years doesn't seem significant enough to seriously steer a decision.
Even if I get to a place where $2 million isn't a significant amount in terms of the happiness it provides me, it's always going to be significant in terms of what it can do. I mean, I think the current figures are around $5,000 to save a life. Take that $2 million and save 400 people's lives. Is that not worth spending two minutes thinking about?

The diminishing marginal utility of money means that these are both basically the same number, unless you're donating your money to those that haven't reach the asymptotic part of this graph.
Yes, which means perhaps the good advice here is to be less selfish, and not more insouciant. You can do a lot of good with that kind of money, even if you insist on waiting until you're dead to do it.
 
I guess it depends on what you see as the best use of money is. Maximizing how much money you end up with in the end seems like an odd thing to prioritize.

One of the whole points of being fabulously wealthy is that you have to worry less about maximizing the value of every last cent.

To state the obvious, the practical value of your fortune drops to $0 when you die. Leaving behind a inheritance is nice I suppose, but surely that's not the primary factor when it comes to wealth management. That's not to say you should blow through the entire thing in your lifetime, but it's also pointing out that maximizing your returns is not really the the only consideration.

The difference say between $100 million or $102 million over 20 years doesn't seem significant enough to seriously steer a decision. The diminishing marginal utility of money means that these are both basically the same number, unless you're donating your money to those that haven't reach the asymptotic part of this graph.

That is an excellent point that serves to demonstrate that it's important to ask the right question. The manner in which is phrased is usually to ask which choice has the higher monetary value: are you leaving a significant sum on the table by making this choice?

A wiser person will factor their goals into the discussion... what do they want the money for, and which choice will serve that best?
 
Cool thing is, there are calculators that tell you how much you would earn based on the state you are in. If I hit the 500M, I could take a lump sum of 193M (plus change) or an annuity over 30 years with the first year nearly 7M and the final year 21M - to total 380M. If I took the lump, used some but kept 190M to invest, I would only need to make 2.5% to beat the annuity.
 
Cool thing is, there are calculators that tell you how much you would earn based on the state you are in. If I hit the 500M, I could take a lump sum of 193M (plus change) or an annuity over 30 years with the first year nearly 7M and the final year 21M - to total 380M. If I took the lump, used some but kept 190M to invest, I would only need to make 2.5% to beat the annuity.
Of course, you're assuming here that you're choosing between taking a lump sum and investing almost all of it and taking the annuity and stuffing it under your mattress. You can invest the annuity payments, as well.
 
The difference say between $100 million or $102 million over 20 years doesn't seem significant enough to seriously steer a decision.
True but as we have seen, the difference between an annuity and a lump sum can be considerably greater than 2%. It can be more than 1/3 depending on how the taxation works.

You don't have to take my word for it. Startz has done an excellent job of explaining why.
 
How did your wife not know about having a close friend? She was a stalker, wasn't she?
:)

The lottery winner went on to grad school and got a teaching credential. They met as they were teaching similar classes. By that time it wasn't very public knowledge except likely among her closest friends and family. It was after they had both retired that my wife learned her friend had won.

Note the win was over 30 years ago back when jackpots were much smaller than today and were paid in equal amounts over 20 years or a lump sum that was quite a bit smaller due to the higher interest rates at the time. Taxes took about 33% out of her yearly 1.x million.
 
Not going to happen for me. I don't play the lottery. I am morally opposed to any gambling game where the house takes 50%. Casino slot machines in my state are limited to a 15% take (which is still a license to steal from the gullible).
 
Not going to happen for me. I don't play the lottery. I am morally opposed to any gambling game where the house takes 50%. Casino slot machines in my state are limited to a 15% take (which is still a license to steal from the gullible).

The key with casino gambling is to get people to gamble continuously. When you do that the expected house take increases with the number of bets you make. Increase is propotionsl to N. Two hours playing slots will produce a very high house take.

Wife's friend rarely played the lottery and just happened to on a whim with $5 change she had after shopping.
 
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I also almost never play the lottery, but being opposed to absolutes and things doctrinaire I buy a ticket every year or so, usually some one of those silly monster powerball things with a chance in the fractional zillionths of zillionths, and a bit as one does here, get to muse for a day or so on all the various luxuries and largesses I'll enjoy when I win it.
 
The future value of 20 * 750,000 is 20,000,000 if you assume a discount (interest) rate of 3%....

And why is that of interest?

20 * 750,000 is still only 15,000,000. No one offers such a terrible deal, no one would accept it.

The future value of 20,000,000 today in 20 years is 36,122,224. So for both options to have equal future value, annual rates would have to be 1,354,583, or a bit over 27 million payed out over 20 years.
 
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And why is that of interest?

20 * 750,000 is still only 15,000,000. No one offers such a terrible deal, no one would accept it.

The future value of 20,000,000 today in 20 years is 36,122,224. So for both options to have equal future value, annual rates would have to be 1,354,583, or a bit over 27 million payed out over 20 years.
The rest of the post that you quoted (but deleted from your quote) made precisely the same point.
 
You take the lump sum.

When someone else holds your money it is at risk.

Unless you've got cash stuffed in a mattress, someone else is always holding your money. And no investment is risk free.

Mark Cubans advice is basically given based on the fact that joe average is a financial moron.

Which is why it's very good advice.

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.

No, not just as easily. You can do it, but there are extra steps, and extra steps provide psychological guard rails making it less likely for most people. It's not perfect protection, but for most people it is protection.

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

Which is another benefit of spreading it out: it's easier for people to come to that realization when they only have, say, one million dollars for the year than they might if they had all 20 million up front.
 
A first consideration are taxes. The next consideration is the net-present-value(NPV) of the annuity vs the lump-sum under some reasonable estimation of return and inflation. Also one must consider a private annuity vs the lottery's chosen annuity.

There are some factual errors in the thread. The US "windfall tax" only applies to corporations and is used an an ex post facto bludgeon by populist demagogic politicians. In the US, lottery winnings are taxed as regular income.

In the US this means a top marginal rate of 37% to the Feds on (adjusted) income above $578k(single) or $693k (married) 2023. You might consider becoming a resident of a non-tax nation before a distribution, but the timing is doubtful. There is a ~$32k/yr tax advantage to being married, assuming a distribution or income necessary to reach the top bracket.

US State taxes vary widely. and 7 states have no income tax. Of these only South Dakota has a short (weeks) presence requirement to become a legal resident. If the sum is quite large it would make sense to change legal residence. Whether you can claim the lump-sum income occurred in the new state of residence is somewhat doubtful.

The current US "Powerball" lottery stands at $1.2billion, which allows 30yrs of $40mill/yr annuity payments OR a lump-sum of $551.7mill ($347.6mill after Federal taxes). If $40mill were your entire income the after-tax amount would be $25,2mill annually.

Assuming you pay 37% on all gains, and get a 10% return (typical S&P) and have 3% inflation - then the real dollars of the annuity vs the lump sum are almost equal.

If instead you invest the lump-sum for long-tern capital gains (23.8% tax rate max) then the lump-sum is worth ~40% more!.

The after-tax annuity income in REAL dollars starts at $25.2mill in yr1, and declines to $10.4mill (2023 dollars) in year 30.
The lump-sum LTCG approach thrown off a gain of REAL $27.7m in year2 (21.9m in yr 1 due to STCG) , but the REAL dollar income stream increases to $92.1mill (real 2023 $) in year 30.

Lump sum is a huge win if you can invest it.
 
The point about capital gains tax being lower is a good one.

However, this is not an apples-to-apples comparison. The 10% return is not "typical," it is average. The annuity is guaranteed; the investment of the lump sum is risky. If you make a safe investment then you can't even make 5 percent.
 
As long as you're all speculating here, let me throw another scenario into the pot:

We know that people get togther as groups to buy lottery tickets, with intention of splitting any winnings in proportion to the amount each person contributes. I am guessing that in most cases, all contribute an equal amount, and would split equally, and then each go their separate ways.

But suppose my daughter and I buy a ticket? I am 80 and she is 50. We have a mutually supportive relationship.

What's the best strategy for us jointly to maximize the amount we receive?
 
The point about capital gains tax being lower is a good one.

However, this is not an apples-to-apples comparison. The 10% return is not "typical," it is average. The annuity is guaranteed; the investment of the lump sum is risky. If you make a safe investment then you can't even make 5 percent.

It's typical in the long run.

Your view of annuities is fundamentally wrong. Risk and return are two sides of the same coin - inseparable . The annuity company is taking market-risk, and a profit, and the cost of insurance, therefore so are you when you hold an annuity. The company could fail. Annuities, like bonds, reduce volatility, not risk, but at a cost of some lower return. Put another way, with $350mill, you can buy or build your own annuity company, and keep their profit. Nothing can prevent catastrophic risk.
 
State sponsored lotteries in the U.S. offer a guaranteed payout. So the appropriate rate of return for thinking about an annuity is something like the return on long-term government bonds.
 
At the moment, the grand prize in Powerball in the U.S. is $1.2 billion. That means either 30 annual payments of 40 million dollars or a lump sum of $551.7 million.

Suppose you are in the 37 percent bracket. If you take the lump sum you are left with $347.57 million. Invested in an annuity paying about the treasury bill rate that's 21.5 million a year. (Approximately, I didn't do the calculations exactly.)

If you are willing to make risky investments that average 10 percent a year you'd get $32.52 million a year.
 
Having $300m cash on hand is way different than having $30m in cash dribble in over time.

I really don't understand why anyone wouldn't take the lump sum when you are in family office territory. This idea that the annuity is safer is a joke, you are going to be able to invest in a wider variety of things with your own family office anyway.

I suppose if you don't trust yourself with money maybe dribbling it out might make sense but probably not.
 
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