Winning the lottery is an exhilarating experience. When you get that lucky ticket, your mind starts racing with ideas of how you’ll spend your newfound riches. But before you start making plans, you have an important decision to make: Do you want to take the winnings over time in an annuity, or take it all at once as a lump sum?
Opting for the lump sum payout gives you all the lottery win money right away. You don’t have to wait for annual payments over decades. But the lump sum is not the full jackpot amount advertised. It’s less because of taxes and math. To figure out how much the cash option really pays, you need to calculate the lottery lump sum.
What is a lottery lump sum?
The lump sum, also called the cash option, is a one-time payment from the lottery. It gives you all the winnings from a jackpot prize at once. But the amount is reduced, or discounted, from the full jackpot.
That’s because lottery winners don’t really get the headline prize amount. The advertised jackpot is based on the total prize if you take the annual annuity payments over 30 years or more. To pay out all the money at once, the jackpot has to be reduced to its present cash value.
The lottery uses various financial calculations to figure out the lump sum amount. Getting the cash option reduces your winnings by about 40 to 60 percent compared to the annuity prize.
How lottery lump sums are calculated
Figuring out the lump sum requires some complex financial math. First, the lottery has to calculate the overall cash value of the prize. This involves determining the amount of money needed today to pay out the full jackpot over decades.
This present cash value is calculated using:
- Interest rates for securities like US Treasury bonds
- The timeframe for the annuity prize
- Costs of administering decades of annual payments
Financial advisers generally use annuity formulas to determine present cash values for jackpot annuities. The specific lump sum calculation methods can vary by state lottery rules.
Interest rates
Interest rates are a key factor in calculating present cash values. State lotteries look at interest rates on US Treasury securities, which are considered low-risk investments. Rates are fixed when the prize is claimed and don’t change over the payment schedule.
Long-term government bonds pay lower interest rates than short-term notes. So the present cash value is lower when calculated using interest rates for securities with maturity dates matching the full annuity term.
Annuity timeframe
For giant jackpot prizes, annual payments are spread over 25 to 30 years. The longer timeframe reduces the present cash value. With more years of payments, money has to be invested longer to fund the full annuity.
Administration costs
It takes money and effort for lottery organizations to administer annuity payments year after year. Factoring in these administrative costs reduces the present cash value of giant jackpot annuities.
Applying the lottery lump sum formula
While the details vary by lottery, the general formula for the lump sum calculation is:
Lottery lump sum = Jackpot annuity x Present cash value factor
The present cash value factor is a percentage that reduces the advertised annuity prize. It’s calculated using the interest rates, annuity timeframe, and administrative costs.
The lump sum ends up being much less than the headline jackpot. For example, let’s say a lottery winner is entitled to a $500 million prize annuity.
If the present cash value factor is 50%, then the lump sum payout comes to:
$500 million x 50% = $250 million
So the winner would get $250 million cash now rather than $500 million paid out over 30 years.
State differences in lump sum payouts
While lump sums are always lower than annuity prizes, the exact amounts vary by state lottery. The reduction percentages range from about 40% to 63%.
For the same jackpot amount, the lump sum will be larger in a state with a higher present cash value percentage. Differences between states result from factors like:
- The annuity term. For example, 30 annual payments versus 25.
- Allowing winners to choose a lump sum versus the lottery automatically paying annuities.
- The particular Treasury rates and administrative fees used.
It pays to check the lump sum policies for your state lottery. Winners should also consult financial experts about the best option.
Powerball vs. Mega Millions
The two biggest national lottery games have different annuity terms and cash options. Powerball annuities are paid out over 30 years. Mega Millions uses a 26-year payment schedule.
In Powerball, the advertised jackpot is based on the 30-year annuity. But winners can choose a lump sum equal to the cash value of the 29-year annuity. This slightly increases the present cash value percentage.
Mega Millions advertises the 26-year annuity amount. The lump sum cash option is lower than with Powerball, with present cash value percentages around 50% to 60%.
State lottery comparison
Many state lotteries use annuity terms of 20 or 25 years. Shorter terms increase the cash value percentage. Texas has one of the most generous lump sums, with a present cash value around 63% of the annuity.
At the other end, Colorado and Indiana annuities are structured to reduce the lump sum to around 40% of the jackpot prize.
It’s important do your homework when choosing between the annuity and cash options. Find out your state’s lump sum rules and consult financial experts about the tax implications.
Examples of real lottery lump sums
Looking at actual jackpots shows how lump sum math reduces multimillion dollar annuity prizes. All these examples are based on two key choices:
- Published annuity jackpot amount
- Present cash value percentage for that lottery
$1.537 billion – Powerball
In 2018, one Powerball ticket matched all the numbers for a jackpot advertised at $1.537 billion. This was payable as an annuity over 29 years. However, the cash value was $913 million, equal to about 59% of the annuity prize.
$1.05 billion – Mega Millions
A Mega Millions jackpot hit $1.05 billion in 2021. The cash option was about $776 million, which is roughly 60% of the 26-year annuity amount.
$656 million – Mega Millions
A 2012 Mega Millions drawing awarded a $656 million annuity prize. The ticket holder opted for the lump sum of $471 million instead, which was around 72% of the full jackpot.
$533 million – Mega Millions
In 2018, the annuity value for a Mega Millions jackpot was $533 million, while the cash option paid $324 million. The winner took the lump sum, which was about 61% of the total annuity.
$451 million – Powerball
A Powerball jackpot reached $451 million in 2017, based on the 29-year annuity. The cash value was $278 million, which comes to around 62% of the annuity amount.
These examples illustrate how the lump sum consistently ranges between 50% to 70% of huge jackpot annuities, depending on the lottery rules.
Should you take the lump sum or annuity?
Choosing between the lump sum and the annuity is a big decision. There are pros and cons to weigh for each option.
Benefits of the lump sum
- Full control over money. You can use it for any purpose instead of waiting on annual payments.
- Investment opportunities. The flexibility to put the money into different assets.
- Avoiding the spotlight. Anonymity is easier with the lump sum versus decades of publicized annuity payments.
Downsides of lump sums
- Higher taxes. Owing more tax upfront versus spreading it across each annuity payment.
- Overspending risk. Blowing through all the money when it’s handed over at once.
- Lost investment value. Annuities may pay more over the long term through interest growth.
Personal situations factor heavily in the lump sum versus annuity decision. For example, younger lottery winners often choose the cash, while those near retirement opt for the annuity.
It’s smart to have financial advisors run projections to see if the lump sum or annuity has the highest payout long-term.
Using the lump sum Payment calculator
To help estimate lottery lump sums, you can use Annuity.org’s Lump Sum Payment Calculator. This tool lets you enter different jackpot amounts, interest rates, and cash value percentages.
The calculator runs the lump sum formula to show the present cash value. You can test different scenarios to see results using various state lottery lump sum payout rules.
Lump sums versus partial lump sums
Some lotteries offer a partial lump sum option along with the annuity. For example, winners might be able to take 60% of the jackpot in cash upfront, then receive the remaining 40% as annual payments over 20 years.
Partial lump sums give flexibility to take some cash while locking in a portion of the total prize money. This can help manage taxes and safeguard against overspending the entire windfall.
Taxes on lump sum payments
Winners face big tax bills when taking lump sums. The exact amounts vary based on federal and state rates. But combined taxes can take out 35% to 40% or more of a lottery jackpot.
Federal taxes
Federal taxes apply a top rate of 37% for lump sums paid in a single tax year. This highest rate starts at incomes above $539,900 for single taxpayers and $647,850 for married couples in 2022.
Large jackpots easily surpass these thresholds. Some cases also trigger an additional federal surtax of 3.8% on investment income.
State taxes
Some states have no income tax on lottery winnings, like Florida and Texas. Others take a bite of lump sums, from around 3% up to over 12% in some areas.
Combined federal and state taxes can reach 40% or more. Spreading taxes across annuity payments often reduces the overall burden.
Withholding
Lotteries are required to withhold taxes when paying out large lump sums. Federal withholding is 24% for winnings over $5,000. State withholding varies.
You still owe additional taxes when filing returns for the year. But withholding helps avoid penalties for underpayment. Some lump sum recipients opt for extra withholding to cover more of the tax bill up front.
Do you pay tax on the full annuity amount?
With annuities, your tax bill each year is based just on that payment, not the entire jackpot. Only the principal portion is considered income. The rest is considered interest and isn’t taxed annually.
Over the full payment schedule, an annuity results in less total tax compared to a lump sum. But annuities come with restrictions on selling off future payments.
Selling lottery annuities
Instead of keeping an annuity, some lottery winners opt to sell off future payments. This gives a large lump sum upfront in exchange for forfeiting remaining annual payouts.
However, most state lotteries prohibit transferring annuity rights. Powerball and Mega Millions strictly limit any selling of future payments.
Secondary markets exist to purchase lottery annuities, but at steep discounts. The lump sums offered often only pay out 30% to 60% of the total remaining annuity.
Winners need to carefully weigh secondary market deals against simply keeping the annuity. There are also tax implications from essentially discounting future payments.
Get professional advice about lottery winnings
With giant jackpot lump sums involved, it pays to seek advice from experts. Financial planners, accountants, and lawyers can provide guidance on:
- Claiming prizes anonymously
- Investing lump sums wisely
- Tax planning strategies
- Setting up trusts and foundations
The right team can help lottery winners leverage their windfall and achieve long-term goals.
Lump sum takeaways
Calculating the lottery lump sum involves reducing the advertised jackpot annuity to present cash value. This results in winner getting 40% to 60% or more of the annuity amount all at once.
Each state lottery has different rules for lump sum payouts. Comparing the options, and the tax consequences, can help winners decide between taking a reduced lump sum or full prize spread over decades.