In June, Floridian Gloria C. MacKenzie, 84, claimed the biggest jackpot in the history of the multistate Powerball lottery: a whopping $590 million. When officials draw from the $425-million Powerball pot tonight, another American may face the decidedly unglamorous question put to lottery winners – namely, lump sum or annualized payouts?
It’s not as simple as it looks.
With a lump-sum payment, lottery winners receive all of their winnings in one go. There’s a catch: The winner receives significantly less money than the advertised prize. When Ms. MacKenzie claimed her lump sum, for instance, she walked away with $370.8 million – a little more than half of her full prize. The winner of Wednesday's drawing will be eligible for a $244.7 million lump-sum payment before taxes.
Even with the prize shrinking, “Almost all the time, people will take the lump sum,” says Kent Grote, a professor of economics and business at Lake Forest College in Illinois. Some lottery winners believe they will get more return on their money if they have all of it upfront to invest or spend, Mr. Grote added.
There are other reasons to take the money upfront, says Kay Bell, a contributing tax editor at Bankrate.com, a personal finance website. "I think people think, 'Who knows what will happen tomorrow?' They can take it all now and figure out what to do with it later."
Being hit by a windfall can dramatically increase your tax obligations, however. The Internal Revenue Service collects 25 percent of the lump sum, and then lottery winners have to contend with a 39.6 percent income tax.
"There's one huge tax bill associated with that, and that's something you have to set a lot of money aside for," Ms. Bell says.
Taking a lump sum can also tempt lottery winners to spend it all, fast. Many past lottery winners have infamously lost their entire prize after soaring to wealth. There was Evelyn Adams, who won the lottery twice – once in 1985, then again the following year – but gambled it all away. More recently, Alex and Rhoda Toth declared bankruptcy years after winning the lottery and ended up in court for tax evasion.
The cautionary tales of squandered prizes have made some Americans opt to receive annualized payments instead.
Under this option, the winner could receive equal installments over as long a period as 25 to 30 years. It’s a choice someone might lean toward if he or she is less concerned about dashing out to buy a Ferrari and more worried about conserving the prize money, Grote says.
“There’s much more temptation to spend the money quickly if you get it all upfront. You can think about someone saying, ‘Maybe I want to have this money for the next 25 to 30 years, and I’m afraid it won’t be there otherwise,’” he says.
Given the sluggish economy, however, Grote says he thinks few Americans are leaning toward this mindset.
“I think a lot of people, particularly in the last five years, have been struggling with their income or with paying mortgages, and having a windfall … people just can’t turn that down,” he says. “Given the financial situation we’ve been in since the recession, I don’t think there’s a lot of people who will want to spread their payments out.”
It’s a scenario made even more the norm by the fact that most lottery players, despite being relatively poor, spend a greater percentage of their household budgets on lottery tickets than the average American. Households earning less than $13,000 annually spent nearly 10 percent of their income on the lottery, a March 2013 study found.
Collecting annualized payments may not save you substantial amounts of money during tax season, either. Winning the lottery is "likely to push you into top tax bracket anyway, and then you’ll have to deal with those tax filings on an annual basis, instead of getting your attorney and tax advisor together once," Bell says.
Of course, the odds of even having to face this question are slim to none. Powerball officials say the chances of winning the jackpot are 1 in 175 million. To put it into perspective, you could buy two tickets a week for the rest of your life and win, well, once every 1,684,841 years on average.