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Lump Sum or Annuity for Lottery Winners?

You’ll pay less in taxes with the lump sum

spinner image A spinning roulette wheel comes to a stop, hitting a jackpot releasing gold coins exploding out from the center of the wheel.
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Somewhere in Florida is a person with a golden ticket, one that has the winning numbers for the record $1.537 billion Mega Millions grand prize. But before the lucky winners can think about whether to have one pool or two in their mega yacht, they have a big decision to make: whether to take the lump sum or the annuity payment, which will be spread out for 30 years.

It’s a problem we’d all love to have: deciding how to take the proceeds after winning the lottery. But it’s a big decision, whether it’s a record jackpot or the current $20 million Mega Millions prize. But how you handle the payout of lottery winnings requires careful consideration and likely the input of experts, such as an accountant, lawyer, and financial planner or wealth management adviser.

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“As a very famous rapper once said, ‘Mo money, mo problems,’” said John P. Schultz, partner at Genske, Mulder & Company, an accounting firm in California. “This could not be more true in the case of lottery winnings, as the wealth — and management of that wealth — has not grown slowly so that someone can learn and grow with it.” He adds that with lottery winnings being sudden and extremely large, people often encounter issues after winning that outweigh the benefits they receive.

Here are four things to consider if your net worth suddenly increases by 10 digits, or even just six figures.

1. Evaluate pros and cons of lottery payout methods

You can get out a calculator or use an online tool to crunch some numbers while deciding what is more advantageous for you: a lump-sum payment or an annuity.

With a lump sum, the winner receives all the money at once, after taxes are withheld. With the cash option, the winner would get $783.3 million after taxes. This can be attractive for someone who has large debts to pay off, helping them dig out of a financial hole. The lump-sum option also allows the winner to invest the money wisely, which can be especially valuable for younger people who have more time to earn on their investments and ride out market volatility.

An annuity spreads the payments over many years and offers a reliable and long-term stream of income. If the winner has not been careful with money in the past, or even behaved irresponsibly in financial matters, then the annuity may make more sense, said Dan Moskowitz, president of Chatham Wealth Management in New Jersey.

“Deciding what method to take your winnings is not as simple as running a calculation of the present value of the future annuity payments and comparing that to the lump sum,” Moskowitz said.

2. Assess tax implications

Before you submit the paperwork for your lump sum or annuity, you need to consider the tax implications carefully.

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Cash winnings will be taxed in the year the money is received, noted Charles Shader, a taxation specialist at Facet, a financial planning firm. He gave this example: If a lump sum of $100 million was received in year one, all dollars earned above $578,125 would be subject to the current top marginal tax rate of 37 percent. Dollars below that threshold would be subject to lower-bracket rates. The result in this scenario would be a tax in excess of $36 million, Shader said.

The Mega Millions annuity is paid out as one immediate payment followed by 29 annual payments. Each payment is 5 percent bigger than the previous one. For a typical jackpot of $100 million, the initial payment would be about $1.5 million, according to Mega Millions, and that payout would grow to about $6.2 million by the 30th year. In theory, you’d pay about the same amount in taxes with the lump sum as the annuity over 30 years, but the annuity would offer lower tax payments per year.

Of course, tax rates can change if Congress institutes new taxes, takes action to extend tax breaks, or lets tax advantages expire. As with all things tax-related, the impact will depend on the person’s specific circumstances.

“Age of the winner and their life expectancy matters; cash flow needs and planning also matters. Their ability to organize and create an advisory team to help them analyze this before they make the decision matters,” said Schultz.

3. Consider heirs and estate planning

As you sort through your options, you will want to think about other people, too, specifically your heirs.

For Mega Millions, annuity payments are paid to the winner’s estate if the winner dies before the annuity prize is paid out, according to a spokeswoman for Mega Millions. Lottery winners should consider what they want their financial legacy to be, especially now that their net worth has grown dramatically, said Moskowitz. The windfall may make the winner feel extra generous, so supporting charities that are important to the winner or even setting up a foundation may be a priority. How much to leave to children or grandchildren is another key consideration, Moskowitz added.

Everyone should have a will, but now that document becomes even more important, because your estate has grown substantially. If you do not have a will yet, creating one should be a top priority.

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As you decide who should inherit your money, there are some factors to consider. Schultz recommended assessing who needs cash flow and when, the future needs of potential heirs and what their plans are. Your financial adviser should also explain about the estate tax, which kicks in only when you pass away. Single filers get a $12.92 million exemption, while married couples get twice that — $25.84 million per married couple. The estate tax is 18 to 40 percent, depending on how much you have over the exemption.

4. Don’t go it alone

Assembling an advisory team should be at the top of your list after winning the lottery.

You will likely want all or some combination of the following to advise you: an accountant; a lawyer, especially one who specializes in estate planning; and a financial planner or wealth management adviser.

“Most individuals who win the lottery have had little to no wealth in their lives before the lottery winnings, so they would not have had a need for a three-pronged team, which we implement with all of our clients with significant net worth: CPA, financial adviser or wealth manager and attorney,” said Schultz.

A financial adviser can help build a comprehensive financial plan that includes how much the winner can reasonably spend monthly, which can be helpful, said Moskowitz.

“First and foremost, winners should spend significant time working on a comprehensive financial plan that incorporates short-term debt and goals, intermediate goals, and long-term goals and legacy. Once the plan is in place, we can figure out the most tax-efficient way to turn the plan into reality,” said Moskowitz.

As you pick the professionals to help advise you, turn to sources you trust for guidance. AARP offers some advice to get you started.  

One last piece of advice: “Winners should NOT tell a soul that they won,” said Shader.

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