The Best Answers Lump Sum vs Annuity Lottery
You don’t become a smart investor when you win the lottery.
Installment payouts are smarter than a lump sum.
And unless you’re a professional investor, it’s way too much money for one person to handle alone.
Before claiming their prizes, have some in-depth conversations with a qualified attorney, CPA, and investment adviser.
What is An Annuity Lottery
An annuity is a series of annual payments (usually of equal size) over some period of time.
There are different kinds of annuities, such as an annuity certain where the payments are made for a fixed number of years, or a life annuity where the payments are made for the lifetime of an individual.
Most state lotteries offer an annuity certain.
The face value of an annuity is the payment amount times the number of payments.
In a lottery, the face value is the amount advertised on the billboards – “this week’s jackpot is $X million!” — although nobody ever gets all the money at one time. The cash value or present value of an annuity is the amount of money, today, that is mathematically equivalent to the series of the payments, given a particular interest rate.
By equivalent I mean that, if you deposited the cash value in an account bearing the agreed-upon interest rate for the term of the annuity, the accumulated amount would equal the face value.
In a typical state lottery, the cash value is roughly half the face value.
Modern lotteries, you see, involve a bit of financial sleight of hand. You’ve “won” $X million only in the sense that you’ll receive that much if you’re willing to wait 20 years to collect it. What you’ve actually won is the cash value plus the interest that accumulates.
The assumption underlying most annuities is that money is constantly productive — that is, there is a time-value to money, represented mathematically as the interest rate. The interest rate is critical in determining whether a lump sum is a better deal than an annuity.
Why You should choose an Annuity lottery instead of lump sum?
The financial analogy is that having all your money in a savings or checking account is like having food in the refrigerator.
Putting money in a mutual fund or certificate of deposit, where it takes some effort (and sometimes penalties and tax consequences) to cash it in, is similar to driving to the store two miles away.
A structured settlement (annuity) is like the 25-mile drive for food.
You have to do a lot of work to sell it and take a huge financial hit when you do.
Should I buy an annuity myself and take the lump sum?
Yes you can!
An annuity is just one tool, just like balancing your money among a number of different investments, but the key to wealth is to develop good savings and spending habits.
Instead of dropping all your money in the market at once, you invest over time, like on a weekly or monthly basis. The returns are usually better than timing the market.
What happens if you die before the 20 or 26 years are up in a annuity lottery payments?
The answer varies by state. In most states, the annual payments continue to your estate and heirs. But that’s worth checking. If the payments stop upon the death of the winner, then you are well advised to talk to a lawyer before you claim your winnings. A lawyer may suggest setting up a trust fund, so that payments will continue to the fund regardless of what happens to you – assuming, of course, that you want your heirs to get the remainder of the money rather than having the state keep it.
The bottom line, then, in deciding whether to take an annuity or a lump sum, includes the following considerations:
- What assumed interest rate is underlying the calculations? Do you think you can earn significantly more than that rate on your own? If so, take the lump sum cash value. If not, go with the annuity.
- What are your financial needs, both immediate and over the next twenty years? Do you need a steady flow of income? If you take the lump sum and invest it poorly or lose it, how much will it hurt you?
- If you give up your job to enjoy your wealth, what will happen if you’re still alive when the annuity payments stop? You don’t want to blow it all in a spree and then find yourself in poverty in your old age.
- What happens if you die before the annuity has been fully paid?
- As noted, there’s the question of whether to ask in advance for an annuity — the tax treatment alone could overwhelm any other considerations.
In short, you probably need to talk to a tax advisor and financial consultant.
Questions about lottery investments?
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