When you buy a lottery ticket, you might think the toughest decision you’ll face if you hit the jackpot is whether to get a red or yellow Ferrari. Before you embark on a jackpot-fueled shopping spree, you need to determine how you want your payout, a lump-sum cash payment or an annuity. While many factors, such as your fiscal self-control, play into whether you should opt for annual payments or take the money and run, it's usually best to take the lump sum.
Potential Tax Advantages
If you win the lottery, you owe taxes on your winnings based on the year in which you receive the funds, not in which they’re won. Because of this, you must pay 35 percent income tax on your earnings if you take the lump sum. If you opt for the annuity, you end up paying the same rates on your earnings unless you receive annuities worth less than $388,500 – a paltry payout in the days of multi-state lotteries – but you are exposing yourself to tax risks in the future. If income taxes increase in the future, you will owe a larger portion of tax when you receive those annuities.
Small Jackpots and Taxes
While the media and most lotto players like to concentrate on lotteries with a huge jackpot, state lotteries commonly provide winners with much more modest jackpots. In these cases, a winner may choose to receive a lump-sum amount of $650,000 or a $50,000 annuity for 20 years, for a total payout of $1 million. Because the annuity amount is relatively small, winners who choose this option are taxed at lower tax rates than lump-sum winners. In these cases, choosing an annuity may have tax advantages, though they may not outweigh other considerations.
Control of Your Money
With the built-in cap on accessing your money created by an annuity, you won’t have the economic flexibility of a big-time millionaire. While this shouldn’t be an issue on a day-to-day basis if you develop a reasonable budget, it doesn’t provide you with full control of your money. Because of this, you may be unable to purchase a mansion worthy of a lotto winner without a mortgage. You also won’t be able to donate lavishly to charity if you hope to exercise your philanthropic muscles. By the same token, if you have a habit of scrambling to pay your bills each month, an annuity may force some fiscal discipline on you, helping you avoid frittering away your winnings.
Interest Rates and Investment Returns
Lottery commissions typically purchase a bond to fund a winner’s annuity; the lump-sum payout is equal to the cost the state would otherwise incur to purchase the bond. Because low interest rates lead to high bond prices, in periods when interest rates are low, lump-sum values tend to be higher than when rates are high, which can give winners more money to invest when rates climb. Invested wisely, a lump sum payment can easily make up its difference in value from its annuitized value, according to Business Insider.
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