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 pay-out 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 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?
{ 6 comments }
