LOTTOpeople Magazine

After winning a large lottery jackpot, should you take a lump sum payment or the annuity?

The answer is not as easy as you might think - your "friends" will surely "advise" you to take the cash and run. In fact, whether you should take the cash value or annual payments shouldn't depend on the jackpot amount as much as on the interest rate reflected in the annual payment.

First some terms: An annuity is a series of annual payments (usually of equal size) over some period of time. There are different kinds of annuities, such as an annuity certain in which payments are made for a fixed number of years, or a life annuity in which the payments are made for the lifetime of an individual. Most state lotteries offer an annuity certain.

The face value of an annuity is the payment amount times the number of payments. In a lottery, the face value is the amount advertised on the billboards - "this week's jackpot is $X million!" - although nobody ever gets all the money at one time. The cash value or present value of an annuity is the amount of money, today, that is mathematically equivalent to the sum of the payments, given a particular interest rate. By equivalent I mean that, if you deposited the cash value in an account bearing the agreed-upon interest rate for the term of the annuity, the accumulated amount would equal the face value.

Using POWERBALL as an example, the cash value is roughly half the face value. To be sure, there is a little bit of financial sleight of hand going on here. You've "won" $X million only in the sense that you'll receive that much only if you're willing to wait 29 years to collect it.

What you've actually won is the cash value plus the interest that accumulates. What POWERBALL does is take the lump sum and uses it to buy government bonds that are put into a 30-year annuity.

The assumption underlying most annuities is that money is constantly productive. The interest rate is critical in determining whether a lump sum is a better deal than an annuity.

Confusing? Let's put the matter in everyday terms. Let's go back to our POWERBALL example. Say you've won a jackpot of $15 million. The rules say that total will be paid out over 29 years (30 payments). Or, you can take the lump sum cash value, which is about half the face amount. Which should you take?

Basically, you want to calculate the interest rate that they're using in converting from the face value to the cash value. Then ask yourself whether you can find investments that earn more than that. If you can, take the lump sum. If you can't, take the annuity and be happy.

Real life, of course, is more confusing than mathematics. That's where the total amount and your personal circumstances come into play. For instance, if you win $15 million at age 75, you may not want payments over 29 years.

On the other hand, if you win $15 million at age 75, you might figure you can't spend half the face value, so you might prefer the annuity. In either case, hire a financial consultant to help you make these decisions.

What happens if you die before the 29 years are up? The answer varies by state. In most states, the annual payments continue to your estate and heirs.

Then there's the question of taxes. Normally, if you can choose the form of payment, you're taxed on the lump sum immediately. Tax on an annuity will probably be less than that on a lump sum, because of the lower rates on lower income brackets. However, you're also gambling on today's tax rates being as high or higher than future tax rates.

A quick summary, then of what you should be thinking about before choosing annuity or lump sum. Ask yourself:

What interest rate underlies the calculations?

Can you earn more than that rate on your own?

If so, take the lump sum value. If not, take the annuity.