Lottery Debate: Take Annuity or Lump Sum?
Almost no one who wins the Powerball elects to take the annuity.
Maybe that’s because people want as much as they can get as soon as they can get it. We’re not too big on delayed gratification.
Some may recall the Stanford Marshmallow test. In it, nursery schoolers were placed in a room with a treat, such as a marshmallow, on a table. They were told that if they waited for the researcher to return, they could have two marshmallows. If they couldn’t wait, they received just one treat. Even though most tried to hold out, only about 30 percent could wait for the extra treat before gobbling up that one in front of them.
Turns out grownups don’t much like waiting for their treats either.
Lottery Lump Sums Lead in Popularity
Winners get 60 days to decide which route to take. Almost everyone wants their marshmallows right away.
If he had chosen the lump-sum, one-time payment, he would have gotten $136.2 million.
In the interim, dozens of winners opted for the lump-sum payments.
Winners may feel they’re better at investing than the government, which runs the lottery. And they may be able to get a better return if they invest the lump sum than if they wait for the annuity payments. And indeed, some financial advisors say that investing the lump-sum payment wisely can result in a significantly better return than the lottery annuity.
Although it may be tempting to take the big pot right now, there are also a lot of good reasons to choose the annuity.
For one, the annuity is a guaranteed stream of income. If a lottery winner blows all his or her newfound wealth, he or she gets another chance next year and the year after that.
Annuities Help Protect Against Long-Lost Relatives
As one expert put it, taking the annuity is a way for the lottery winner to be protected from himself. The protection extends to the long-lost friends and relatives bound to pop out of the woodwork with outstretched hands, as well as the con artists with questionable investment schemes. It’s a way to minimize the risk of becoming another cliché, the lottery winner gone broke.
Some people think taking the annuity is risky because if they die before the payments run out, then the money is lost. But Powerball, for one, pays no matter what. If the winner dies, the payments go to the winner’s estate.
According to the New York Times, there are tax advantages for taking the annuity. Powerball invests the entire cash value of the prize before taxes are paid in government-backed securities. The earnings on the investments aren’t taxed because Powerball doesn’t pay taxes. With the lump sum, the winner has to pay taxes on both the payout and any money made through investments.
The other tax advantage is paying income tax on 30 smaller annual amounts may very well result in a smaller tax bite than would affect the lump sum.
Still, some advisors recommend taking the lump sum and using some of it to purchase an annuity from a private company. This helps insure against blowing through all the money in a short time, while allowing the winner access to a big pot of money right away.
You might consider this a split-the-marshmallow approach.