For this answer, we turned to Marissa Chien, EA, president of Advantage Tax Plus, Inc., a tax and wealth-planning firm in Las Vegas, and co-author of Huntington Press’ Tax Help for the Frugal Gambler. One of her specialties is tax planning for people who gamble -- and hit jackpots. She has many professional and recreational gamblers as clients, including Jean Scott, author of The Frugal Gambler and More Frugal Gambling. She can be reached at 702/207-1040 or [email protected].
Many factors are involved in deciding whether or not you should take the lump-sum or the annuity payments when you hit a progressive jackpot like Megabucks or the lottery.
There are three quantitative factors. The first is the discount of the lump-sum payment; in other words, how much less of the jackpot you'll get if you opt for the lump sum. For example, you hit a Megabucks jackpot for $10 million. That amount is the total you’ll receive if you take payment in 25 annual installments, which includes interest on the principal projected over the two and a half decades. If you opt for the lump sum, you’ll only receive something like $6 million -- the principal without the projected interest.
Here, you have to decide if you’re better off taking the fixed interest on the principal or if you can earn more than $4 million on your principal over 25 years by investing in the open marketplace. It’s kind of like buying a package travel deal -- airfare, hotel room, and rental car -- or trying to do better by buying the three elements separately.
The second quantitative factor is the age of the winner. The younger the winner, the more time he or she has to take risks; therefore he or she should probably lean toward the lump sum. The older the winner, the more he or she should lean toward the taking payments, especially if the discount is significant.
However, an older winner should also take estate taxes into account. This depends on the size of the jackpot and the winner’s other assets. Currently, you have to pay taxes on estates worth more than $1.5 million fair market value. So it might be better for an older winner to take the lump sum to avoid the high estate taxes on the remaining payments after he or she dies.
The third factor consists of two fancy financial-planning concepts: "time value of money" and "opportunity costs." These refer to the prevailing earning rates of money when you have the opportunity to put it somewhere other than a simple interest-bearing account. Quantitatively, accountants can assign values to both.
There are also two qualitative factors. The first is the winner’s risk profile. Someone who’s averse to risk should lean more toward the annuity, which is "guaranteed" money. If you take the lump sum, you might also have to take your lumps if you invest it unwisely, or even wisely, but then something unexpected happens in the market you’ve chosen. Either way, if you take the lump sum, you have to figure out what to do with all that money.
The second qualitative factor is family issues. If you have a big family, some of whom you suspect will want to dig their claws into your money, you’d probably want to take the payments. That way you can dole it out a little at a time -- perhaps even from the later payments -- so that your grasping relatives won’t try to get their hands on a large perecentage of the whole amount in one grab.
Also, if you yourself are a spendthrift and fritter away money as soon as it arrives, it’s probably best to take the annuity, which becomes a sort of forced allowance plan.
Summing up: My best advice is that if you’re fortunate enough to hit such a jackpot, the first thing you need to do is to consult with an accountant, who can provide you with a detailed analysis of your options. The key is that everyone's situation is different. The factors are many and the possibilities -- both good and bad -- are endless. Expert advice in this situation is critical.
