Dear Dr. Don,
I won a state lottery. There is no lump-sum payment option available, so I am scheduled to receive 20 annual payments of $50,000, or $35,000 after taxes.
Several companies have offered to give me a lump sum equal to half the total payment stream, or $500,000, before taxes. Over 20 years I would receive $700,000 after taxes with the annual payments. I have debts of about $100,000, but I have additional income of about $100,000 besides the lottery payments.
I figure that after taxes with a lump sum, I would end up with somewhere between $250,000 and $300,000. Should I keep the annuity or sell it? Either I or my estate is guaranteed the $35,000 annual payments from the lottery.
The decision to assign the payment stream to a firm in order to receive a lump sum today will, as you point out, also accelerate the income tax obligation to today. You'll pay ordinary income taxes on the lump-sum payment.
The maximum federal income tax rate of 35 percent plus any applicable state or local income taxes would reduce the $500,000 lump sum to around $300,000 after-tax. (I'm assuming an additional 5 percent in state income taxes.)
Comparing a $300,000 after-tax lump sum to a $35,000-per-year after-tax payment stream over the next 20 years -- assuming the first $35,000 payment is received today -- gives an implied interest rate of 11.55 percent. Bankrate's "
Savings withdrawal calculator" confirms these numbers.
In other words, you're paying more than 11.5 percent to this firm in order to get your money today. For you to be better off investing the lump sum, you'll have to earn more than 11.5 percent on your investments -- after taxes.
Good luck with that.
There have been a host of lottery winners who have regretted winning. Read the Bankrate feature, "
Unlucky lottery winners who lost their money." Don't be one of those winners. Keep a level head and don't spend above your means.
You have the power to make this the windfall that it is. Enjoy it responsibly.