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?
The former option is called a lump-sum award, where the winner receives the amount of the lottery winnings after taxes. The latter option, to enter into a long-term payment agreement, is called an annuity. Annuities allow recipients to receive decades of periodic disbursements from an account set up for them by their state lottery commission.
Each state and lottery company varies — Powerball, for example, offers lottery winners the choice of a lump-sum payout or an annuity consisting of equal annual payments over 30 years. Mega Millions offers lump-sum payouts and annuity payments that increase by 5% each start over a 30-year period.
Both lump-sum payouts and annuities have their 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.
Another downside is temptation — the financially illiterate may squander the funds all at once or not invest it properly, leading many lottery winners to bankruptcy or a financial loss. In 2002, West Virginia lottery winner Andrew Whittaker took a $170 million lump-sum payout and was robbed several times. Now, at 70 years old, Whittaker still has to work to pay his bills. In another example, 1981 lottery winner Lou Eisenberg is now living on his pension in a trailer because several divorce settlements separated him from his $5 million winnings.
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.
Taxes largely influence many lottery winners’ decision whether to choose a lump-sum payout or annuity. The advantage of the lump-sum is certainty — the lottery winnings will be subjected to current federal and state taxes as they are now. Once taxed, it 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 current federal and state rates. Those who choose the annuity option for tax reasons are often betting the tax rates in the future will be lower than the current rates.
For those who choose an annuity predicting lower future tax rates and later regret their decision, lottery winners always have the option of selling their annuity payments for a lump-sum.
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. In addition to funding an emergency expense or paying off debt, many seniors also sell their annuities because it is illegal to transfer annuity payments from a living winner to anyone else.
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.
If you are interested in selling some or all of your annuity payments, you should also contact your lottery company to clarify if the annuity can be sold. Some lottery companies only allow for a transfer of the funds when the annuity owner dies.
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.