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It’s probably one of the most luxurious decisions in all of human history, and only a select few ever get to make it: When you win the lottery, do you take the lump sum or the annuity?
As it stands now, the Powerball jackpot is at $700 million. We calculated which option is the better one when the jackpot hit an eye-popping $1.5 billion, and the same logic applies. Here’s what we found.
With the annuity, the winner gets $1.5 billion parsed out in slowly increasing annual intervals, beginning at $22 million and ending at $92 million paid 30 years down the line. The other, more popular possibility, is a fat, one-time lump sum of $930 million. (Both figures are pre-tax; as you’ll see below, taxes take a big chunk out of either payout.)
What’s the better deal?
To past winners, the answer has been pretty obvious. From the available Powerball records, only four people have actually chosen to take the annuity (two groups that won jointly chose a mixture as well), despite the lump sum being a lower nominal amount. By our own calculations, taking the lump sum does indeed make more sense.
Numbers-wise, $1.5 billion is obviously larger than $930 million. If you’re simply putting all of the winnings into a mattress, the annuity, of course, makes more sense. Though you wouldn’t have to, you’d more likely invest (wisely) with the help of a newly hired fiduciary financial adviser.
If you invest all of your post-tax winnings into a low-price stock index fund and get a very reasonable annualized return of, say 5%—Ibobotson’s yearbook cites annual returns of 10.1% for large cap stocks since 1926—the lump sum would turn into $2.1 billion after 30 years. If you instead took the annuity and invested every year’s payout, your total would only be $1.5 billion. This includes the capital gains tax of 20%.
Business Insider, which conducted a similar exercise a few years ago, did the math factoring in an annual allowance of $1,000,000—a little “don’t mind if I do” money seems reasonable enough. With that added, the lump sum still trumps the annuity after 30 years—by double.
From our calculations, the break-even point between the lump sum annuity is at a risk level of about 3.2% annual returns, for both the save-it-all model and the “don’t mind if I do” model. Here’s a deeper dive into a few other aspects that might affect your decision.
From a tax standpoint, there’s probably no real difference—you’re going to be smack dab in the highest federal or state bracket no matter what you do.
But with the annuity, you have some more flexibility in this sphere. You could immediately buy a house in New Hampshire or California (or any gambling tax-free state) and establish residency by living 183 days a year and adopt New Hampshire’s 0% sales tax. Then, the 29 subsequent payments of your winnings wouldn’t be taxed on the state level. That move could save around $131 million—still not enough to warrant the annuity over the lump sum, however. You could also (potentially) move to Puerto Rico and pay only the first year’s federal taxes of around $9 million and keep the rest of the $1.49 billion tax free. Invest all that yearly (with your spending money), and you’d have $2.4 billion after 30 years.
Still, the lump sum trumps the annuity.
Future Tax Brackets
All this math depends on the top-tier income tax bracket not moving. If big changes took place, future annuity payments would be affected, significantly. If Bernie Sanders were to enact an aggressive tax plan, the lump sum model would come out even more significantly ahead. On the other hand, if Ted Cruz won and established his 10% flat tax next year for the next 30 years, that would shake things up considerably. In that scenario, you’d come out ahead if you could get better than 5% annualized returns on the lump sum. Doing so could require you to take on risk that you might prefer to avoid. But you could certainly afford some risk, and again, a 5% target over 30 years isn’t particularly extreme.
Our calculations for the future of the lump sum are depending on you not spending that much, since nearly all of the money is invested. But could you give yourself have a bigger allowance and still come out on top with the lump sum option? Let’s say you want to spend $10 million, every year. After capital gains taxes, it just takes an extremely conservative interest rate of 3.2% for the lump sum to come out ahead of the annuity. With a more reasonable return of 5% annually, you’d get $1.5 billion after 30 years with that hefty allowance. If you took the annuity and spent $10 million annually and invested the rest and got the same returns, however, you’d have $997 million three decades later.
Behavior and Utility
This analysis would not be complete without discussing two things: utility and behavior. If you don’t have the foresight to hire a competent money manager, you might find yourself with a mess. Plenty of lottery winners have gone bankrupt, though admittedly with fortunes many orders of magnitude smaller. Obviously, if you take all of the winnings at once, that means you can blow through it quicker than if it were doled out over a few decades. So if you don’t trust yourself with the lump sum, or don’t want to worry about investing or budgeting, the annuity might be attractive.
Josh Barro of the New York Times argues lottery winners should absolutely take the annuity, citing tax advantages and protecting you from yourself. If you really don’t want any risk (sigh) and really can’t be trusted, he’s right. The behavioral argument is compelling. But it only takes a small amount of risk to make the lump sum pay off—the risk required for just 2.06% annualized returns (still factoring in our $1 million annual allowance).
And what if you die? If you take the annuity and pass away before 30 years are up, you’ll never get the whole amount, because, well, you’ll be dead. Sure, the Powerball will continue to pay the annuity to your heirs (who will have to pay estate taxes), but you personally won’t get to use it. Maybe that matters to you.
Then again, maybe none of this really matters, especially when you consider the diminishing added utility of $1 billion to $2 billion. If you’re a Koch brother and want to finance campaigns you might see that extra cash as very useful, but for most people that’s just gravy.
Still, it might be fun to have.