Lottery winners can receive prizes in a lump sum 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 jackpots, they must usually make one important decision: Should they collect their winnings all at once or over a long period of time?
The first option is called a lump-sum award. That’s when the winner receives all of the lottery winnings after taxes at one time. The second option, a long-term payment agreement, is called an annuity. Annuities give recipients a stream of periodic disbursements from an account created by their state lottery commission.
Each state and lottery company varies. Powerball, for example, offers winners the choice of a lump-sum payout or an annuity of 30 payments over 29 years. Mega Millions offers lump-sum payouts or annuities. The annuity offers an initial payment followed by 29 annual payments. Each payment is 5 percent larger than the previous one.
While both options guarantee a lottery payout, the lump-sum and annuity options offer different advantages. Choosing a lump-sum payout can help winners avoid long-term tax implications and also provides the opportunity to immediately invest in high-yield financial options like real estate and stocks.
Electing a long-term annuity payout can have major tax benefits
Federal taxes reduce lottery winnings immediately. But winners who take annuity payouts can come closer to earning advertised jackpots than lump-sum takers.
Consider the case of $228.4 million Powerball jackpot winner Vinh Nguyen, a California nail technician and sole top-prize winner of that game’s drawing on Sept. 24, 2014.
Most big-prize winners opt for the lump sum. That would have been $134 million. Instead, Nguyen opted for the annuity. That will give him the full $228,467,735 jackpot paid out over 30 years.
Those payments include interest that will accumulate from investments over the life of the annuity.
Annuities also protect winners who might otherwise spend everything after a lump-sum payment.
Some winners may squander their funds all at once or not invest it properly, leading them to bankruptcy or other financial troubles.
An annuity isn’t for everyone. Annuities are inflexible, prohibiting winners from changing the payout terms in the case of an unexpected financial or family emergency.
The annual payments may prevent a winner from making large investments. Such investments generate more cash compared to the amount of interest earned on the annuities.
Taxes also influence many lottery winners’ decisions on whether to choose a lump-sum payout or an annuity. The advantage of a lump sum is certainty — the lottery winnings will be subjected to current federal and state taxes as they exist at the time the money is won. Once taxed, the money can be spent or invested as the winner sees fit.
The advantage of the annuity is the exact opposite — uncertainty. As each annuity payment is received, it will be taxed based on the then-current federal and state rates. Those who choose the annuity option for tax reasons are often betting that tax rates in the future will be lower than the current rates. However, should they regret their decision in choosing an annuity payout, lottery winners do have the the option of selling their annuity payments for a discounted lump sum.
If you are interested in selling some or all of your annuity payments, you should contact your lottery company to clarify if the annuity can be sold.
There are currently 28 states that allow after-market sales of lottery annuities for a lump-sum payment
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.
The lottery winner must have court approval for the transaction to take place. A judge decides whether such a sale is in the person’s best interest.
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In spite of rumors that the government gets to keep the money, lottery annuities are generally passed to the winner’s heirs. In fact, some lottery companies allow for a transfer of the funds only when the annuity owner dies. In this instance, any remaining assets will be disbursed to the estate or a living beneficiary until their death or the end of the contract.
Some lotteries will cash out an annuity prize for an estate, to make it easier for the estate to distribute the inheritance and to pay federal estate taxes when they apply. In order for the lottery to do this, it has to be allowed in the state where the ticket was purchased.
Lottery winners who decide to sell their periodic payments must first 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.
Typically, two types of companies purchase long-term lottery payouts: factoring companies and insurance companies. These are the same companies that purchase settlements from sellers who collect personal injury settlements and other kinds of long-term payouts.
Factoring companies offer lottery winners immediate cash for their annuity contracts. They are buying the lottery winner’s future payments. The cash payment is less than the total of the scheduled annuity payments.
The company should offer you a quote in writing at no charge.
The annuity purchasing companies are part of a very competitive, heavily regulated market. Ask the company where they are certified and licensed and how long the quote is good. Ask about any fees and how long the company has been in business.
When selecting a buying company, it’s usually best to look for a company with experience and that has people who take the time to explain the written offer. Do not cave to pressure to sign something before you fully understand and agree.
The company you choose will draft a contract detailing the proposed agreement. The proposal has to be approved by a judge, who will determine if it is in the best interests of the lottery winner. The annuity purchasing company will take the contract to the judge.
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Someone who cashes in some or all future lottery payments will owe federal income taxes. This differs from the sales of structured settlements from personal injury lawsuits. In those cases, buyouts are tax-free.