So what? The lottery is just one of those fun things that we do as a way to strike it rich, right? For some folks, that's true, but for others—often those with the least amount of money to spare—playing for these jackpots can be a serious income drainer.
An overwhelming amount of lottery participants seem to reside in the lower economic classes, according to the stats. Lottery retailers collect commissions on the tickets they sell and also cash in when they sell a winning ticket, usually in the form of an award or bonus.
A curious headline was placed on the homepage of the Mega Millions website on March 25, , a day when the odds of winning flew up to 1 in million. The headline read, "Save for Retirement. Is there a better, more profitable, way to spend or invest the money you'd otherwise devote to the lottery?
Let's look at the numbers. Of course, the stock market is never a sure thing. Stocks can depreciate as well as appreciate. So let's try a more cautious estimate. Let's say, despite the dismal odds, you do win the lottery, and you win big—six figures big. You're going to face a lot of decisions, and the first one is how to receive the funds.
With most lotteries, you get a choice: they can write you a check for the lump sum amount or you can receive it in the form of an annuity. The lump sum is a single cash transfer, whereas the annuity is a series of annual payments often spread out over 20 to 30 years.
Unlike some annuities that end when you do, this is something called an annuity certain : the payouts will continue for the set term of years, so if you pass away, you can bequeath those payments to whomever you would like. Which should you take? Only six states allow winners to remain anonymous, while three others allow them to collect winnings through an LLC. Most lottery winners opt for a lump sum payment. They want all of the money immediately. That is the main advantage of a lump sum: full and complete access to the funds.
Not only do individuals like that, but their newly acquired giant team of accountants, financial advisors , money managers, and estate lawyers do too—the more assets under management, the better, especially if their compensation is based on a percentage of those assets.
Taking a lump sum could also be the better course if, not to be morbid, the winner isn't likely to live long enough to collect decades of payouts, and has no heirs to be provided for. You may be in a better income tax position if you receive the proceeds over several years via an annuity rather than up front.
Lottery wins are subject to income tax both federal and state, except for the few states that don't tax winnings in the year you receive the money.
If you take the lump sum option, the entire sum is subject to income tax that year. However, if you choose the annuity option, the payments would come to you over several decades, and so would their tax bill. Not according to the experts. If you choose the annuity option, the government takes your winnings and invests them for you—most likely in boring, yet highly stable Treasury bonds.
Usually, when you invest, you pay taxes, but when the government invests they do so free of all tax obligations. If the government invests it, you only pay a tax bill once on the annuity checks. But perhaps the biggest argument for taking the annuity is more intangible—to protect you from yourself. A six-figure windfall is a life-changing event, and not necessarily a good one. Most people are inexperienced at managing such sums to begin with, but even the wisest and coolest of heads could lose perspective, especially given the avalanche of friends, family, and even strangers that descends once the news gets out, pleading or even demanding a share of the spoils.
Academics cite research showing most lottery winners will save only 16 cents of every dollar they win and that one-third of lottery winners go bankrupt. An annuity can help, by literally limiting the funds in your possession. After all, you can't give away, squander, or otherwise mishandle what you don't have. Plus, taking the money over time provides you with a "do-over" card. By receiving a check every year, even if things go badly the first year, you will have many more chances to learn from mistakes, recoup losses, and handle your affairs better.
Inheritance factors are generally free standing but there can be some considerations where lottery inheritance is involved. Taxes are generally withheld from lottery distributions at the time they are paid out. If payments are made in a lump sum, the inheritance can be passed along tax free since inheritance gifts are generally not taxed.
If the payments are still coming in as an annuity, taxes will be withheld. As in all inheritance scenarios some estate taxes may be required if values exceed the exclusion limit.
Since lottery winnings push many people into the high net worth category, estate taxes may be a factor. This can be a challenge if the heirs do not have the cash on hand to do so. In some states Powerball will convert annuities to lump sums upon death to help better manage any tax burdens.
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