Let’s say you win a that big lottery prize. I mean, really big. Like $10 Million or more. The first and most important decision you need to make is whether to take a single payment upfront (usually called a lump sum payment) or get your prize in annual payments (usually called an annuity). You can only make this decision once, and can’t change your mind after, so it’s important to understand the difference. Most people seem to think taking a lump sum payment upfront is the smarter way to go, but let me outline the differences and you can make up your own mind.
What is A Lump Sum Payment vs. Annuity?
According to most lotteries, including Mega Millions and Powerball, an annuity provides annual payments over a specified number of years. For example, Mega Millions offers an annuity that is Over a 26-year period. For every $1,000,000 in the jackpot, you will receive approximately $385,000 per year before taxes. The lump sum payment, or cash option, on the other hand offers you a one time single payment TODAY. However, the cash option takes the value of the jackpot over the course of 26 years and converts it into TODAY’s dollars. So for example, a $500 Million jackpot may offer the one time payment option of around $350 Million. It sounds like you are getting less money, but in reality it is just the jackpot value adjusted for today’s dollars, so you are not missing out. Plus, as described below, you have the opportunity to INVEST that money today and the potential growth outweighs any perceptions that you are taking a smaller sum.
Benefits of Lump Sum Cash Payment
There are many benefits to taking your prize as a lump sum cash payment. These include:.
- Normally, tax on an annuity will be less than that on a lump sum, because of the lower rates on lower income brackets. However, you’re also gambling on today’s tax rates being as high or higher than future tax rates. So depending on where you think tax rates are going, you may prefer to pay your taxes now, if you think tax rates may increase in the future.
- Invest now to make even more money. When you get a big cash payment upfront, you can work that money. With that much money, even a relatively modest return of 3% annually can add up to a lot. With an annuity, you will have a much smaller pool of money to work with each year.
- You don’t have a crystal ball. Who knows what could happen over the next 26 years that you are getting your annuity payments? The organization running the lottery could go bankrupt. Also, each lottery differs on what would happen if you passed away before all the payments were made.
Benefits of Annuity
- Guaranteed Money. Some people like the idea of having a guaranteed payment every year. Perhaps you are worried you might blow all your money if you get it all at once, and would like the assurance of getting money every year.
- You may prefer to also pay your taxes each year, rather than upfront all at once. This may seem less painful.
Which is better? I think a lump sum cash payment is better for the reasons stated above. If you do win a big lotto prize, like the one we will be offering right here at RewardIt, than make sure you think it through carefully before deciding.