When a lottery player wins the Mega Millions jackpot, they are faced with a big decision – do they take the winnings as an annuity spread out over 30 payments over 29 years, or do they take it as a one-time lump sum cash payment? There are pros and cons to both options, so winners need to carefully consider their specific circumstances before making a choice. This article will break down the key differences between the annuity and cash payouts to help lottery winners understand their options.
Annuity Payout
The annuity option pays out the full jackpot amount, but splits it into 30 graduated payments over 29 years. Here’s how it works:
- The initial payment is made shortly after winning, followed by 29 annual payments.
- The payments start smaller and increase by 5% each year.
- The 30th and final payment is the largest of all.
- The total amount received over 30 years matches the announced jackpot.
For example, if the jackpot is $1 billion, the first annual payment would be around $33 million. The payment would then increase by 5% each year until the 30th and final payment worth around $76 million. In total, the winner would receive the full $1 billion over three decades.
The biggest advantage of the annuity payout is that it provides a stable source of income for the rest of the winner’s life. They don’t have to worry about investing or managing the money – they can just relax knowing checks will arrive annually. It spreads the tax burden out over many years as well.
However, there are disadvantages too. Waiting 30 years to receive the full amount is a long time. The annual payments are locked in and can feel small compared to the headline jackpot amount. And if the winner passes away, remaining payments may go to heirs and beneficiaries rather than their personal estate.
Cash Payout
Choosing the cash option provides the winner with a one-time, lump-sum payment upfront. Here’s how it works:
- A single payment is made to the winner shortly after the drawing.
- The amount is significantly lower than the headline jackpot.
- For Mega Millions, the cash value is usually 50-70% of the total jackpot.
- Taxes are deducted immediately based on federal and state rates.
As an example, for a $1 billion jackpot with a cash value of $600 million, the winner would receive around $300-380 million after taxes. This is obviously an enormous amount of money. However, it pales in comparison to the full $1 billion annuity.
The advantage of the cash payout is gaining immediate access to a substantial chunk of money. The winner can invest the funds, pay off debts, make purchases, support causes they care about, and more. Everything is on their timeframe. The downside is receiving perhaps only 30-40% of the announced jackpot. Taxes also take a big bite, including up to 37% for federal taxes alone.
Factors to Consider
When deciding between annuity and cash, Mega Millions winners should consider these key factors:
Current Age and Health
Younger, healthy winners may favor the annuity, while older winners may want cash to enjoy during their lifetime. Annual payments totaling the full jackpot amount are more valuable over decades.
Financial Situation
Winners free of debt may opt for cash, while those struggling financially may want the stability of annual annuity payments. Annuities help prevent reckless spending and rash investment decisions.
Investment Experience
Experienced investors with high risk tolerance may take the cash to invest aggressively and try to achieve greater returns. Risk-averse winners may prefer the fixed annuity.
Tax Implications
Because taxes on annuity payments are spread over 30 years, the overall tax burden is lower compared to lump-sum cash. This favors the annuity option.
Estate Planning
Annuity payments continue for heirs, while cash is potentially part of the winner’s taxable estate. Proper estate planning is important, especially for older winners.
Advisors
Financial planners, accountants, lawyers, and investment advisors are invaluable resources to assess each winner’s situation. Their input should carry significant weight.
Lifestyle Desires
Those wanting to maintain a similar lifestyle may choose annuity. Winners who want to immediately upgrade their lifestyle may prefer cash. Some find a blended approach balances their short and long-term needs.
Desire for Privacy
Remaining anonymous is easier with annual annuity payments versus a high-profile lump sum payout. For winners wanting privacy, an annuity avoids publicity.
Top Pros and Cons
This table summarizes the key advantages and disadvantages of each Mega Millions payout option:
| Payout Type | Pros | Cons |
|---|---|---|
| Annuity |
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| Cash |
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Taxation Differences
Winner’s tax liability is dramatically different depending on if they choose the annuity or cash payout. Here’s a comparison:
- Annuity: Federal taxes apply to each payment annually based on that year’s income level. State taxes also apply annually. Overall tax rate tends to be lower.
- Cash: Federal taxes take an immediate bite of 25-37% off the top. Additional state taxes apply. Combined federal and state tax can take 40% or more of the lump sum.
For example, the federal tax burden on a $500 million cash payout could be $150 million or more. Spread out over 30 years with an annuity, the federal tax may total half that amount. State income taxes show a similar difference.
Marginal Tax Bracket
Annuity payments are taxed annually based on the winner’s income level for that specific year. Typically, their annual income keeps them in a reasonable marginal tax bracket.
With cash, the winner’s income skyrockets immediately putting them in the highest 37% bracket for federal taxes and a high bracket for state taxes. This huge one-time income spike results in enormous taxes.
Tax Deferral
An annuity allows tax deferral since payments are spread over decades. The winner owes nothing on future payments until the years they are actually received.
With cash, there is no tax deferral – the lump sum is fully taxable immediately upon payout. This concentrates the tax hit.
Tax Planning
Multi-year tax planning is possible with an annuity to minimize bracket creep. With cash, the winner must immediately deal with the tax implications of their ballooned income that year.
Tax Reduction Strategies
Annuity winners have 30 years to employ various tax reduction strategies each year. With cash, attempts to reduce taxes are limited to the tax year of the payout.
Returns Comparison
To compare total returns, we need to run projections on invested cash. Assuming a lump sum is invested and earns a 6% average annual return over 30 years, it would grow to around $2.65 billion before taxes.
This exceeds the $1.6 billion from a $1 billion annuity over the same period. However, the winner must pay tax on investment gains. With an effective 25% tax on gains each year, the after-tax net proceeds of investing the cash lump sum come to approximately $1.9 billion.
The net outcome is:
- Annuity: $1.6 billion after taxes paid annually
- Cash invested at 6%: $1.9 billion after annual taxes on gains
So while investing the lump sum can result in higher gross proceeds, the tax drag on investment earnings makes the net proceeds reasonably close to the annuity. And annuity payments avoid investment risk entirely.
Life Expectancy
Life expectancy is an important consideration. Let’s compare outcomes based on living to age 80, 90 or 100:
Age 80: Winner would receive around half of the total annuity payments. Net return is less than invested cash.
Age 90: Winner would receive majority of annuity payments. Returns now favor the annuity.
Age 100: Winner would receive all annuity payments. Annuity provides significantly higher net return.
Younger winners have longer time horizons to potentially realize greater returns by investing cash. Older winners may not live long enough to fully benefit from long-term annuity payments.
Inflation Impact
Over a 29-year payment period, inflation can significantly erode purchasing power.
Let’s consider a $10 million first annual payment from a $1 billion annuity jackpot. Assuming 3% annual inflation, here is the declining real value of that payment each decade:
- Year 1: $10 million
- Year 10: $7.4 million
- Year 20: $5.5 million
- Year 30: $4 million
While annuity payments increase by 5% annually, inflation runs steadily at 3% in this example. By year 30, the real spending power of that payment is less than half of the initial amount.
This demonstrates the impact of inflation in eroding the long-term real value of fixed annuity payments. Winners should weigh their personal inflation assumptions when assessing the two options.
Default Risk
Annuity payments are guaranteed by law to be made for the full term. In the highly unlikely event the state lottery has insufficient funds to make payments, the state is legally obligated to pay winners.
There is essentially no default risk with the annuity. Cash obviously has no risk either once received by the winner. However, there are inflation and investment risks once a lump sum is in the winner’s control.
Fee Impact
Fees can take a bite out of invested cash over time. Assume a winner pays 1% in annual advisory fees to manage investments. On an initial $500 million cash lump sum, that totals $5 million in fees every year.
Over 30 years at that rate, fees would consume over $150 million. The annuity has no fees or costs that reduce payouts.
Spending Ability
The annuity provides stable annual income the winner can count on. But most expenses come from cash flow, not net worth. Annuity payments may not provide enough spending ability for major purchases.
Conversely, cash makes any size purchase possible immediately. But research shows most lottery winners burn through a lump sum quickly with excessive spending. Annuitizing forces budgeting.
Ultimately cash offers greater flexibility for big purchases IF the winner is disciplined. Wise winners will avoid spending more than their annuity income even if they take the cash.
Control and Legacy
With cash, the winner has full control over the funds from day one. They dictate how the money is spent and invested. Any remainder goes to heirs or charity when they pass away.
Annuity winners have less control and flexibility. Payments stop upon death unless heirs were designated (reducing estate taxes). Winners must live within the annual payments.
For those wanting to control their legacy, annuities may be perceived as too rigid. Of course, financial planners can help winners maximize control either way.
Fees
Fees can take a bite out of invested cash over time. Assume a winner pays 1% in annual advisory fees to manage investments. On an initial $500 million cash lump sum, that totals $5 million in fees every year.
Over 30 years at that rate, fees would consume over $150 million. The annuity has no fees or costs that reduce payouts.
Conclusions
While the cash option is alluring, for the average American, choosing the annuity is generally the wiser path to lasting financial security. Here are main conclusions:
- Annuities provide stable, guaranteed income for life that cannot be outlived.
- Cash payouts seem large but are heavily taxed immediately.
- Investing cash brings risks that annuities avoid.
- Many winners spend through cash quickly with little long-term benefit.
- Annuities spread taxes out over time lowering the overall burden.
- Inflation erodes the real value of fixed payments over the long run.
- Life expectancy plays a big role in maximizing the payout choice.
- Financial advisors are critical to review individual circumstances.
- Preserving a sudden windfall requires discipline under either option.
For average Americans, annuity payments provide a lifetime of steady income and financial stability. Investment risks, reckless spending tendencies, tax implications, inflation, and more all favor the annuity. Still, professional advice specific to each winner’s situation is invaluable before deciding.
Both payout choices have advantages and disadvantages. But the annuity option eliminates many risks that could otherwise cause a massive jackpot to evaporate quickly with little to pass on. Savvy winners will carefully weigh these factors before cashing in a winning Mega Millions ticket.