This is what ‘s called a high-class problem…deciding how to take your lottery winnings. Annuity payment or lump sum option? With the size of today’s jackpot, I thought it would be a good time to see how much of a difference there can be between the two payout options.
The Annuity Option
The data from http://www.usamega.com is showing a jackpot of $1,600,000,000 for this Fridays drawing. They publish annuity payout analysis for each state, which breaks down the annual payment you would receive if you won. Here is their analysis:
That’s a pretty healthy annual payment over the next 30 years, even after tax. I imagine that would satisfy the lifestyles of most people.
The Lump Sum Option
They estimate the net payout for the 1.6-billion-dollar jackpot for Texas would be $694,412,000. In comparison, by taking the annuity payments you would receive $1,215,999,990 over 30 years. Which means you would receive $521,587,990 more with the annuity over 30 years. Keep in mind, these are after tax figures, which they use 24% for their estimation.
So, is it worth giving up over 521 million over the next 30 years by taking the lump sum? Most lottery winners will elect the lump sum, if given the choice. But most people don’t think in terms of how to maximize their winnings after they elect the payout. I ran a calculation for taking the lump sum option and investing the money to compare to the annuity. For the calculation, I figured an annual 5% withdrawal from the account increasing each year for inflation. The investment returns I used are from the actual S&P 500 (total return) over the last 30 years.
Here are the numbers:
As you can see, by investing the funds and paying yourself, you end up with substantially more money after 30 years. Not only have you received more income, but you still have over 2 billion dollars in the account.
To compare this against the annuity chart provided by http://www.usamega.com, here are the annual after-tax withdrawals from the lump sum investment.
As you can see, if market returns were like the last 30 years, you would have taken out over 2 billion dollars in income over 30 years! And don’t forget about the one billion plus still sitting in the account. With all else equal, this shows how powerful compound interest can be over a longer time horizon. Multiply that with a disciplined financial approach and you have optimized your wealth and wealth for generations!
Keep in mind, other factors can apply, such as additional taxes, or investment performance. Taking the lump sum and being financially savvy can build much more wealth over time than the annuity option. However, in the end, the quality of lifestyle can’t change too much with either option! Both payouts will give someone the ability to live any lifestyle they want, if they make smart money choices.
Within any financial plan, being exposed to a large amount of money can be overwhelming for many people. The problem with taking the lump sum is most people will not be financially disciplined to manage the money on their own. Everyone has heard stories of lottery winners that spent all their winnings and now live a worse lifestyle than before they won! The other argument is that investment returns can vary tremendously from year to year, so the annuity option offers a level of consistency. Therefore, the annuity option can be a better choice from a behavioral standpoint as it keeps your payout in check.
It’s worth noting, you probably wouldn’t invest the entire amount or the lump sum in the S&P only. By diversifying, even earning an average return on half of the money still amounts to greater wealth.
No matter if you win the lottery or not, it always helps to understand your personal finances, in the event you happen to receive or win a pile of money one day! Understanding your finances will transform into smart money choices that can help you build wealth. Also, if you happen to win, I know someone who can help with the financial advice! And they even disclose this on the mega millions website: “We strongly encourage winners of large prizes to get professional financial advice.” Good luck!
*Numbers calculated are for illustrative purpose only