Uncle Sam A lucky winner in Indiana just made some serious dough. Powerball lottery officials say just one winning ticket was sold for Saturday night’s $314 million jackpot. The six Powerball numbers are 2, 8, 23, 29 and 35, with a Powerball of 19. [Editor’s note, as per usual, I would not have chosen any of those numbers, which is why I remain lottery/daily pick/whatever “win free”.]
That’s a whole lot of cash. Chances are, the winner will opt for a lump sum payout rather than the annuity; that tends to be the most popular option. Lump sum payments can range from between 1/3 and 1/2 of the gross winnings.
Armchair investors always champion for the lump sum amounts because they estimate that they can make more money investing the money than the lottery folks can. Maybe. With the annuity option, the lottery officials will invest the amount, pre-tax, and pay out principal and earned interest over a period of time (usually 30 years). The lump sum option requires the payment of taxes upfront before a pay-out (withholding is required, usually at the highest tax bracket) – therefore the initial amount to invest will be lower than the post-tax annuity investment. Of course, if you invest the money at a much higher rate than the lottery officials, you win. If not, you lose.
Brad Duke is one of the success stories. He won a $220 million Powerball and opted for the lump sum payment. After taxes, his lump sum payment was worth $85 million. Prior to claiming his winnings, he hired a team to help him, including a financial investor, a lawyer and a publicist. He came up with a plan to parlay the $85 million into $1 billion and went to work. He didn’t go crazy with the spending. He didn’t put all of his eggs in one basket. Today, he’s on his way to being a billionaire – all while in his 30s.
But, just getting advice isn’t always a guarantee. Consider Andrew Cicero. He won $5.5 million in 1995. Cicero initially took his prize as an annuity, which was required under state law. He was to receive 25 annual payments beginning at $98,000/year and increasing each year as the investment grew. Five years later, an investment firm convinced him to sell the future payments in exchange for a lump sum ($2 million) that he could invest at a much higher rate. But it didn’t work out that way. It was the year 2000. And Cicero’s investors at SmithBarney put almost 100% into stocks – heavy on tech. He lost about a third of his winnings, he claims. And he owed the IRS almost a quarter million dollars more in penalties and interest; he believed that the lump-sum buyout could be taxed as capital gains (not so). His is just one of many sob stories based on bad advice and bad luck.
Hopefully, that Indiana winner is out there, quietly assembling his or her team, who will think the entire process through. If they’re smart, those folks will consider not only the long-term financial implications but the short-term tax consequences of winning the jackpot. And they’ll give practical, well thought out advice.
If it’s not you – if you missed out on the Powerball, take heart. The Mega Millions prize will be worth about $250 million – and the drawing is tomorrow! If you won, what would you do with your millions? Annuity or lump sum? And what would you spend/invest the money on?
No comments in 2 years, will you read my comment? I’ll chance it.
I think the annuity is a very sensible choice. Most people aren’t sensible; after winning, a certain greed factor takes over, and now they feel they can even make more money.
The way I look at it, even winning the smallest Powerball jackpot means you are basically free from financial worries for 30 years. For the majority of winners, that takes them well into their retirement years anyway. $20 million is many times more than most folks could expect to earn in a 30 year period. So you should be free from financial worries with the annuity; now the problem with taking the “Lump Sum” is, instead of being free from problems, you just created for yourself a big one, namely, now what are you now going to do with it? How are you going to invest it? How do I maximize it, how do I keep from losing it?
Is that really the way to enjoy your newly found financial freedom? Is that really how you want to spend your day, your weeks, your months? You’re given the chance to never have to worry about money, yet you choose an option which forces you to think about it every day. Some say, just hire an advisor, but you’re still having to oversee everything, approve everything, make sure you’re not getting taken for a ride, etc. You could be steered into risky investments, things you don’t understand, and you can’t take your eye off the ball. That sound like more trouble than worth, and may be the reason a lot of ‘rich’ folks are not really that happy. Or end up like Willie Nelson.
I agree – have you ever seen that show (I think it’s on A&E) where they follow the lottery winners to see what happens? Cool idea for a show.
At any rate, one of my first tax compliance cases was a couple that won the lottery and had never paid any federal income taxes on the money. They spent it all on trips, restaurants, etc., – nothing that could really be repossessed – and they were being chased by the IRS for their share. It was a pretty sad story, really, because it’s hard to present a compelling and sympathetic case to the IRS for folks who just blew through a lot of money really quickly.
I wanted to add this but forgot. Does anyone know why the Powerball folks have this all-or-nothing choice between the 30 year annuity and the Lump Sum? I have another theory that the reason a lot of winners take the Lump Sum is that the first year payout (and the next few years actually) are so modest in relation to the amount won. It seems like a reasonable option is that they would let you take however much in Lump you want, then spend the rest on an annuity. To the Powerball people, it comes out the same.
For example, the current Powerball jackpot is $161 million, with a Cash (Lump Sum) option of $80 million. Which means that if you choose annuity, they take the $80 million and invest it in an annuity, less the modest(!) first year payout of $2,870,646 (after takes, about 1.7 million). But if you have your heart set on a condo in San Diego on the water, 1.7 million might get you a 1900 square foot unit, and you’d have nothing left for food, property tax, etc.
So it seems like they should let you take what you want up front for big items first year (for some it might be $10 million out of the $80, others $20 million out of the $80), then conservatively put the rest into the 30 year annuity to give yourself the freedom from financial worry.
To Powerball, it wouldn’t make any difference. What does it matter to them if they buy an $80 annuity on your behalf, or give you the $80 million in cash, or use my blended option and give you $20 million up front and buy a $60 annuity? It’s 80 million out the door in any case.
Any thoughts?
Right or wrong, I think most people would rather have a dollar today than a dollar tomorrow. And I also think, true or not, that most people think they would do a better job of investing and/or spending the money themselves.
On the Powerball side, I suspect it’s administrative closure. They write a check and they’re done.
I believe even in the case of an annuity they are also still simply writing a check – to some investment house buy the annuity. Just like the winner (or anyone for that matter) can buy an annuity, the only difference is if they take the lump sum, the money has already been taxed (or taxes due) and buying an annuity after the fact makes no sense. Or does it?
I was just talking to my brother last night about it (while watching the Miami Heat trow the LIN-Sanity Fever into the Miami river!), and this is the way I feel right now. I would definitely take the annuity. My main reason is that I feel I would be betraying my 9-year old daughter, and my future grandsons by trowing away $ 20 millions so I can have $ 32 millions today. Being honest, being paid close to $ 1 million the first year is more than enough for me. And then I get another million the following year, and so on for 30 years. I guarantee you I will be able to do all the things I want to do with a million every year. Even if I went out to eat every night I wouldn’t spent more than $ 40K a year. Traveling all over the world does not take that much money. Giving to charity (St. Jude’s Children Hospital is my favorite!) would also be possible. So, I would take the annuity, and my daughter will be very happy when she grows up.