Hypothetical: take the lump sum or payments?
Posted by MarkMay 28
At what point do the 30 year payments make more sense than a lump sum payment for large awards like winning the lottery. Assuming you’re like me and in your 30′s and healthy (expecting to live well more than the 30 year payout). Lump sum’s usually incur higher penalties and taxes and are smaller right? but putting the money in some conservative investments at some point should give you a better return at some dollar amount than taking the money over 30 years (and investing it as it comes in).
a little clarification…. I’m about the common state lotteries here in the USA and as a hypothetical, all winnings would be invested.
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Payments.
Being able to predict your income is useful when you’re managing your finances. 30 years of payments = 30 years of predictable income. As opposed to one amazing year – wow! – and then an unpredictable future.
Yes, you’re correct about most lottery payoffs giving you more money when you choose the installments as opposed to the lump sum. They assume most potential winners will want the money up front, and accept the smaller amount. This is complex, but drawing on their capital now costs them potential future interest – costing them money – so paying up front is more expensive, and the lower payoff is probably justified.
If you are careful with your big lottery payoff, saving and investing sensibly, seeking good advice, limiting the amount you spend on impulse in that exciting first year, then you might just make it to retirement with enough left over. But more people aren’t this sensible, especially not right after they’ve won the lottery. Winning the lottery could trigger rash, impulsive behavior, behavior that could easily become bad financial habits of the kind that lead to problems in the long run, even for people who are very rich.
There could be a theoretical point where the prize size is so big that it doesn’t really matter — billions of dollars, for example — but there aren’t lotteries that pay this much. A payoff in the millions is more likely, and a million dollars today doesn’t go as far as it once did.
I hope you win! Whichever way you choose to collect.
A lot of lotto winners manage their money poorly. If you take a lump sum and go bankrupt, you lose everything. Taking a payout would probably make you more responsible. If you had $250,000 a year vs. $3.5 million in the bank, wouldn’t your spending habits be saner? I’m not sure, but I also think your future lotto winnings wouldn’t be lost if you went bankrupt after taking the annual plan, but that’s one to check with a lawyer on.
It’s almost always smarter (meaning you’ll end up with more $$) by taking a lump sum. And here’s why…
There is, in Finance a concept of the future value of money. That means that a $1 today is worth more than $1 10 years from now. So… If you take a lump sum and take the ONE-TIME tax hit, you can invest all of the money today… and reap the benefits forever.
If you take the annuity payment (spread out over 20-30 years) the payment stays the same over the period. So the payment will be actually worth LESS each year. Plus you’ll be taxed at some unknown level each successive year.
Take the lump sum, and invest and kick back. There’s only 1 year of ‘pain’, instead of 20 years.
You would have to do a cost-benefit analysis to determine if you can make more money by investing. Usually you can and this insures you will receive the full amount, rather than dying before the payments are up. There is a mathematical way to do this, but is a bit complex to explain here to someone with no financial background. It all depends on what return you can get on your money and if you die or not.
And you have to consider WHO is running the lottery–some states could mismanage the money and it won’t be there in a few years to make those "time" payments (and they will be earning interest on YOUR money, not you)…personally, I would take the lump sum (usually half the jackpot and then half of that after taxes) and have it be done and over with and see a financial planner to make smart investments with it…
LIVE!!!
I got better things to do than collect a monthly check from a lottery centre…what if you move to another country, or travel often,
or like me have better ideas that can make more money than the extra they pay out LOL… i guess thats why they give you a choice…you can be lazy and have an income coming in, or work still with the money and make even more..
There are several problems with the 30-year payout. For starters, if you take the lump sum you pay taxes on it all at once and get it over with, as opposed to taking it over time where inflation eats away at the actual value of the money you get — your annual payments don’t go up, but the cost of living does at a rate of 2% to 4% per year. After 30 years, your annual payment could end up being worth less than half of what it was when you first won the jackpot. Secondly, you’re giving the state an interest-free loan over the course of your payments while you could be investing the money and earning interest for yourself. Finally, if you were to die before the 30 years is up (Heaven forbid) the payments stop and the state keeps the rest of that money, so the beneficiaries of your estate don’t get any of it. You’re really better off taking the lump sum, paying the taxes on it, then investing the bulk of what’s left (you know, allow yourself between $1 million and $2 million to buy a new house, pay some bills, go on an exotic vacation, etc., but put the rest away and let it work for you).
Assuming we’re talking about the ultimate return on invested dollars – and that means money that you’re going to let grow without withdrawing – then you’re going to be better off taking the lump sum. The option which pays you out over years assumes a very conservative return, and investing the lump sum even in a money market account would yield you more over the same payout period. A present value calculation on both progress payments and lump sum would give an apples-to-apples comparison – it’s fairly easy to do on a financial caculator like an HP 12-C.
If you actually have this decision to make for real but don’t have the background to do the calculation yourself, pay a financial advisor to do just this calculation and explain it to you. Then put your money in a liquid money market account and take a few months to do research and decide how you really want to invest. Good luck.