It is commonly thought by many that if you win the lottery, then you automatically receive all of your winnings at once upon turning in your ticket. In contrast, another conception is that the government takes half of whatever your winnings are for taxes.
The truth of the matter is sort of a combination of both of the aforementioned ideas. When you win the lottery, there are two options of payment to choose from: The Cash Option, also known as the Lump Sum, or the Annual Payout, also known as Annuity Payments.
Lump Sum
If you choose the lump sum, you are choosing to receive your winnings all at once. However, it will not be the full amount. The specifics depend on the state and size of the jackpot, but generally, choosing the lump sum lottery payout will award you roughly half of the winning amount (more or less — the government on average withholds up to 25% of lottery winnings but it varies under different laws, ordinances, and jackpot amounts)
ex: If the jackpot was $12 million, you would receive around $6 million up front, with the other half going to taxes.
Annuity Payments
If you choose the annuity option, you will receive the full jackpot amount, but not all at once — the payments will be spread out over a number of years. Again, the specifics depend on the state and size of the jackpot, but, to use the $12 million example once more, you could take $461,538 per year for a period of 26 years. Also, with an “immediate” annuity, you may be able to receive your first payment within a month of turning in your ticket.
Lump Sum Cash v. Cash for Annuity Payments?
Although it may seem like a cut and dry decision between choosing a lottery payment option, it is actually a more involved process. There are many factors that play a part, and it is wise to weigh both before making a choice between cash for annuity payments or the outright cash option.
Tax Effects
If you choose to be paid via lump sum, then you will automatically owe income taxes on the entire amount in the year paid, which will most likely push you into a higher tax bracket. However, spreading out the payments over the years will result in you only owing taxes on the cash for annuity payments per year.
Investment Effects
The lump sum option is considered to be fair by many state agencies due to the fact that you can get the advertised jackpot amount if you wisely invest your proceeds. The state lottery, however, can invest the entire present cash value of the jackpot while you will only be able to invest the amount after taxes have been accounted for, or the after-tax amount.
Therefore, in order to match the state’s payment installments, you would need to earn a significantly higher investment return on your lump sum than the state would need to get.
General Money Management
Your money management skills will come into play in the decision between the lump sum cash or the cash for annuity payments. There have been many cases throughout history of lottery winners who blew through their jackpot money in a few years and ended up considerably worse financially than they were before they won.
The annuity option allows you to learn from any possible mistakes/mismanagement each year, while, since the lump sum is a one-time payment, any mistakes or mismanagement made with that amount cannot be undone.
Your age may also come into play in your decision-making process. Younger winners have been known to choose the annuity option as a financial base for a business or lifestyle. Older winners have been known to prefer to receive all of their winnings at once via the lump sum option so that they may be free of money worries for their remaining years.