What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


What Is Better, Taking a Cash Option or Annuity in the Lottery?

Original post by Linda Ray of Demand Media

Take time to decide how you'll take your winnings.

When you win the lottery, especially if you pick all the winning numbers, you're going to find yourself with considerable wealth. How you receive and spend that sudden windfall determines how long the money will last and how comfortable you are with the continued returns. As a winner, you may choose between taking the entire sum in one lump, minus taxes, or spread out your payments over a number of years. An experienced investor may do well with a lump sum payment, but you might consider annuity payments if you are a novice in the field.

Contents

Options

Taking your money at once is called a cash option. If you choose to spread out your payments, that is referred to as the annuity option. Payments for the Powerball lottery are paid out in 30 payments over 29 years, with the first payment made at the time you turn in your wining number. The graduated payments are designed to keep up with inflation by guaranteeing a 4 percent increase each year, according to Powerball.com. States invest lottery annuity money in U.S. savings bonds. The lottery advertises its annuity option at a much higher payoff, usually about twice the total amount you'd get if you take the cash option. In addition to earning interest on the amount invested, you also pay fewer taxes overall when you take the annuity option.

Advantages

Taking your money in one lump sum allows you to take advantage of investments that are higher-yielding but riskier than those provided by government bonds. With the assistance of a solid financial adviser, you may turn your lump sum into a lifetime of income. On the other hand, by taking annuity payments, you don't have to rely on risky investments to ensure your income. You won't be required to make costly decisions about what to do with your money to make sure you continue to reap the benefits. The annual payments come with a minimum assurance and may even be larger than you expected if the market does well.

Disadvantages

A lump sum requires that you make sound financial decisions if you expect to use the winnings over an extended period of time. You may place your trust in an unscrupulous investor and lose extensive sums. A lump sum payment comes with other obligations you'll need to learn about, such as gift tax rules that only allow you to give a certain amount of money to your children and relatives each year. You'll have more charities and new friends asking for money if you have a large amount available to you. A lump sum can prove disastrous if you don't have much experience with wealth and investing procedures, according to the American Bar Association. By taking the annuity payments, however, you place all your investment abilities in the hands of the government, which may not deliver the best return on your funds.

Misunderstandings

Many lottery winners believe that by taking the cash option, their tax liability is complete. While state and federal tax collectors will take a portion of the winnings at the time of the payment, future tax obligations may be due. You'll have to keep some funds set aside to cover the extra taxes you may owe on the winnings. Lottery winnings are charted as ordinary income on your taxes. With an annuity agreement, you have more time to learn the various tax codes and can make changes each year that affect your liability. For example, in your third year of collection, you might become a grandparent and choose to set up a trust for your new grandchild. You may change financial advisers if you are not happy with your current rates of return. In short, you'll have more time to become accustomed to the income and can employ your new understanding as you learn.


                   

Resources

References

About the Author

Linda Ray is an award-winning journalist with more than 20 years of research and reporting experience. She has covered health care and fitness for newspapers and magazines, including the "Greenville News," "Success," "Verve" and "American City Business Journals." Ray has also reported on hospitals, commercial development and society. She holds a bachelor's degree in journalism.

Photo Credits

  • BananaStock/BananaStock/Getty Images


Advertisement