Did you win the lottery? If you are reading this, I will assume you did. You are asking yourself whether to take the lump sum or the 20 year payout option. Our Weymouth office is on the opposite end of Columbian Street Lottery office so we get more than our fair share of lottery winners around our office. To be fair, most are lost and looking for directions.
Lottery Payment Options
If you won a large sum, say $1M or more, you have the option of taking a lump sum or a 20 to 30 year payout on your winnings depending on the lottery and state involved. I believe Massachusetts offers a 20 year payout. The 20 years are guaranteed so if you die, someone else gets to spend it.
The pros to the lump sum include a boatload of money right now! The cons are that you won’t get the full prize. You might get 60% of the prize money. In addition, you will be thrown into a higher tax bracket, This means a bigger chunk of money will go to taxes.
In this case, if you take annual payments, you do not have a boatload of money burning a hole in your pocket. You will eventually receive the full prize. And, you may save a chunk on money on taxes.
Which one is better?
On smaller prizes, say $1M to $3M, you may be better off with the payment option. It is very easy to spend the lump sum of money and paint yourself into a corner financially with a house and grown up toys that are too expensive to maintain. They payment option can provide an income stream for many years after your prize. Additionally, because the annual payments are smaller, they will be likely be taxed at lower rates.
On larger prizes, say greater than $20M, you may be better off with the lump sum. Even the reduced amount is difficult to spend down and should be able to provide an income stream on its own. Because the annual payments are larger, the tax becomes more equalized between the lump sum and the payment options.
I crunched a few numbers on a $2M prize and a $50M prize. I also made the following assumptions: 5% rate of return, $20K spent per year on the small prize and $120K per year spent on the larger prize. On the $2M prize, the payment option is better after year 13. On the $50M prize, the payment option does not catch up until year 16. That being said, the greater the rate of return, the better the lump sum is.
Other Lottery Considerations
How old are you? Remember, you cannot take it with you.
Do you still want to work? Are you working for the weekend, do you have a meaningful career, or would you prefer neither?
How responsible are you? Are you going to make it rain like you are insane in the brain, or would Homer chide you as ‘Boring!’?
Do you have questions about Winning the Lottery?
WorthTax can help you work through all the IRS and State rules. If you have any questions, please call Alex at 781-849-7200 and make an appointment today.