Which Lottery payment option is best from a tax aversion perspective, cash payout or annuity?

Answer 1

When choosing a lottery payout option, making it based solely on tax avoidance is a fool's mission.

You should always base ALL financial decisions on MAXIMIZING WEALTH, not just minimizing taxes. While the tax aspect has to be considered it must be given its correct weight, no more and no less.

Keep in mind that the principal way that you minimize taxes is to minimize taxable income. You'll NEVER maximize your wealth that way! As long as tax rates are below 100%, ALWAYS take the extra income and pay the tax. You'll have MORE money in your pocket when the ink dries on the check that way.

While an annuity certain gives you the total number of dollars offered and does minimize the tax burden you have to keep two things in mind, neither of which can be predicted.

First off, the effects of inflation will erode the value of those dollars in the future. That $400k annual payout looks great on paper today but if those dollars are worth less than $80k in 20 years you will have lost a LOT to inflation. It would only take a burp of double-digit inflation like we experienced in the late 70s and early to mid 80s to permanently skew those numbers in the wrong direction. Since it's not possible to accurately predict the pressures of inflation the only way that you can protect yourself is to deal with it in today's dollars. That leans heavily in the direction of taking the reduced lump sum.

The next unpredictable issue is taxation. Sure, under the present law you'll pay less tax in the long run if and only if tax laws stay static. Since laws are at the whim of Congress you can't depend upon taxes remaining the same. There would be nothing to stop them from passing a law that would wipe out the tax advantage of future annuity payments. Again, advantage to the reduced lump sum as you know what todays tax burden will be for certain.

The overriding consideration is the time value of money. You take out a loan, you pay interest. You put money in savings, they pay you. Pretty simple stuff, really. Now I'd never recommend dumping a major lottery hit in a bank savings account -- unless you could negotiate a much more favorable rate which may be entirely possible; money does talk, and loudly so -- but careful infestment of the entire proceeds of the reduced lump sum payout even after paying the increased tax bill right now puts far more dollars to work for you right now, not 10, 15, 20, or more years in the future when those dollars may be worth 1/5th of what they are today.

Answer 2

If you win a lot, It almost doesn't matter.

In fact, it's better not to have a payout going on when you die.

If you win $10M and take a cash payout, the state doesn't give you $10M. They give you X. If you take a payout, they buy an annuity that I believe they buy an annuity where the total payments received equal $10M. It's unknown if you, as a private investor, could beat the return on the annuity.

The X value on $10M all at once pushes you into the highest bracket for that year and most of the money will be taxed at that highest rate. If you take the remaining money, don't spend it and get taxable interest, you will add that interest income to your tax bill in the following years.

Getting 1/25th of $10M gives you $400K a year which if you aren't working would give you some income at every tax bracket before you get to the highest one. It also prevents you from spending the remaining money since you don't have it yet.

Answer 3

It is almost always better to get the money in one lump sum. Then you can invest it immediately. If you choose the annuity, because of inflation, your payment each year, although it is the same dollar amount, will be worth less than the previous year.

Answer 4

Annuity.

In a lump sum cash payout, there is no way that you are going to offset the income with legitimate business expenses and other tax shelters, so you will lose a lot of it as taxes.

But if you are smart, you will use the money to start a business, and then every business expense ends up offsetting a lot of that income, so your net income ends up lower and you pay a lot lower taxes.

And if you are really smart about it, you could end up like the really rich and pay almost zero taxes. This is what always cracks me up about the "tax the rich" rhetoric. It is incredibly easy to pay ZERO taxes if you have a lot of money. The whole system is structured to give the very rich every imaginable tax shelter that there is. This is why a "fair tax" will never, ever happen. If they had to truly pay the same amount of tax as everyone else, based on what they SPENT, they would have to pay real tax dollars for the first time ever in their lives.

Besides, from a historical viewpoint, the ones who take it as a cash payout almost always go completely broke. The ones who keep having a huge chunk of money show up each year have a fresh boatload of cash to blow each year.

Answer 5

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