Lottery Annuity Vs. Cash Payout

Winning a lottery jackpot means facing a big financial decision -- do you take the annuity payout over decades or the lump sum in cash right now? You need to carefully consider the many factors affecting that decision, such as taxes, your investing skills, your financial circumstances and your life expectancy. Most states give lottery winners up to 60 days to decide how they want to take the money.

...
Consult a financial adviser before deciding between lump sum or annuity.

Annuity Basics

The jackpot value in lottery ads assumes you take the annuity payout, says the MegaMillions lottery website. What you win is the present cash value plus accumulated interest over the annuity payout period. If you elect the cash payout, you typically receive about half the advertised value. With the annuity, the lottery agency takes the cash jackpot and invests it in an annuity based on ultra-safe securities such as U.S. Treasury bonds. The state assumes all investment risk and guarantees your payments. As of September 2010, a Treasury bond-based annuity would pay about $35,000 per year per $1 million invested.

Tax Differences

If you take the annual payments, the state lottery invests the entire cash jackpot in the annuity on a pre-tax basis. Taxes come due only on the amounts paid to you each year from the annuity, says the MegaMillions website. But if you elect the cash payout, the state must withhold 25 percent for federal and state income taxes, so you immediately have 25 percent less to invest than the state does. That means you would have to earn 25 percent more on your money than the state, just to stay even.

Investing Skills

Paying a lump sum of cash that’s only half the advertised jackpot value is perfectly legal because the lottery assumes that if you invest wisely, you will end up with as much as if you took the annuity. This means that each year you will have to earn, on an after-tax basis, enough to equal the after-tax value of that year’s annuity payout, according to an August 2004 article on the Financial Planning Association’s website. If you, or your financial adviser, have the investing skills to earn more than the annuity, you will come out ahead by taking the cash. Otherwise, you will be better off with the annuity.

Other Considerations

There are many horror stories of people who mismanaged their lottery winnings. The Financial Planning Association’s website says that with annual payments, money managing mistakes will be confined to the current year, letting you learn from your mistakes and move on. But if your financial circumstances require large sums of cash for things like clearing up debts, paying for college or starting a new business, the cash option might be better. On the other hand, the annuity guarantees steady income for the next 25 to 30 years. Your life expectancy also is a consideration. If you're old, you may want the cash now rather than waiting decades for the money. But you might choose the annuity as a legacy. If you die, states will pay the remaining annuity installments to your heirs.