Lottery winners can choose to receive payouts in one lump-sum payment or through an annuity that provides annual payments spread over a long-term period. There are pros and cons involved in either choice.
Before lottery winners can collect their jackpot, they usually must make one important decision: Do they want to collect their winnings all at once or over a long period of time?
In many cases (though not in every state), they can choose a one-time, lump-sum award or they can enter into a long-term payment agreement. These come in the form of annuities and allow recipients to receive years or decades of periodic disbursements from an account set up for them by their state lottery commission.
Each choice has its pros and cons.
Lottery winners who consider themselves savvy investors typically pick the lump-sum option so they can beat the long-term market returns by immediately investing the money in high-yield financial options, including real estate, commodities, precious metals, stocks or bonds.
On the other hand, taking the money now means they can make extravagant purchases or pay off large amounts of debt with their newfound, upfront cash.
The downside of an immediate influx of cash is that the actual payout is significantly less than the amount won in the lottery.
For example, when three Powerball winners split a $448 million prize in 2013, they didn’t individually collect a third of that jackpot – roughly $150 million. Instead, the federal government first applied its tax rate of 39.6 percent to the winnings. Many states also tack on their taxes to the remaining total. Each winner in this example was left with about $90 million dollars – hardly a bad pay day.
One reason to look hard at a long-term annuity is the potential tax benefits. Depending on the amount of the winnings, individuals who choose annuity payments over the lump-sum payment can fall into a lower tax bracket. They also will always receive a larger payout over the long run.
There is a major downside to receiving lottery winnings in an annuity: Unexpected financial emergencies that periodic payments might fail to meet.
Perhaps a lottery winner wishes to live free of debt, but cannot achieve that goal because their periodic payments are too small to completely satisfy all outstanding obligations. Marriage, a new home, sending a child to college, addressing a medical emergency or start a new business might require more liquid funds. Selling one’s lottery payments may be the best possible solution.
Many lottery winners who decide to take the annuity have an option to cash in that long-term investment. Currently, there are 28 states that allow these kinds of after-market sales for a lump-sum payment.
A winner does not need permission from those states’ lottery commissions to sell the rights to future award payments. Winners also can decide to sell all or part of their future payments. The terms of the sale, including the total amount, are up for negotiation.
However, just like the transfer of payment rights under the provisions of a structured settlement for personal injury, the winner must have court approval for the transaction to take place. A judge makes the decision whether such a sale is in the person’s best interest.
Typically, two types of companies purchase long-term lottery payouts: Factoring companies and insurance companies. These are the same companies that work in the secondary annuity and structured settlement market that purchase settlements from sellers who collect personal injury settlements and other kinds of long-term payouts.
Lottery winners who decide to sell their periodic payments for upfront money first must learn if they are allowed to do so. That is often determined by the state in which the lottery was won and not by the state in which the lottery winner lives. Sometimes there are ways of finding a loophole; a task best suited for a personal attorney.
Someone who cashes in some or all future lottery payments will owe federal income taxes, and in some instances state income taxes, on the amount of the lump-sum payout. The tax rate will be the ordinary income tax rate.
This differs from someone who sells a structured settlement gained from a personal injury lawsuit. In those cases, buyouts are tax-free.