When I play the lottery, I have to choose between a lump sum and annual payments. Does it matter?
With hard-to-beat odds of winning the average lottery game, it probably doesn't matter. Should you beat those odds, however, choosing between a lump sum and annual payments does make a difference and depends largely on your personal needs and goals. In either case, you'll pay federal taxes and in some cases state and local taxes, according to the prize amount and your existing financial status.
With a lump-sum disbursement lotteries pay out a percentage of the jackpot in a lump-sum (typically 40 to 50 percent of the jackpot amount). Depending on the state and lottery rules, your payout option may be selected before or after your win. If you select the lump-sum option, you'll receive a large chunk of cash for your immediate use. You may spend or invest it as you like.
There are big benefits to taking the cash in a lump sum. Used judiciously, it can improve your finances by eliminating debt and improving your lifestyle. If invested wisely, it can potentially grow dramatically and become the basis for a significant estate. Of course, you'll need to consider the inherent risks of investing and get some professional assistance.
The annual-payment option invests the value of the estimated present cash value of the advertised jackpot amount in securities over a period of years (usually 20 to 30 years). Using this option you will receive more money by the time you receive your final payout, but your spending power will actually have decreased due to inflation. It also gives you less money that can currently be put to work. Even if you invest a large part of your annual payout, the growth will be limited by the size and incremental nature of each investment.
The annual-payment structure, however, offers the possibility of a budget-based approach to your winnings. You'll be less able, and therefore less likely, to spend it all in one extravagant spree. Depending on your goals and financial position, this can be the safer option. With discipline, you can create a solid estate as well.