Why take the one-time payout for the Lottery?

dukerdog wrote:

What are the factors that I'm neglecting in this calculation?

Heartbeat risk. If the two payment streams are equal, then heartbeat risk says you should take the lump sum.

Someone should do a documentary about past big money lettery winners. I would love to know what the hell they do mentally and socially as well as financially with their sudden class upheaval.

If you have ever used Excel extensively you'd realize that the mouse is such an inefficient method. Take some time to learn key combinations.

The mouse is for girls.

Of courese they are equal - at a given cost of capital. The question is, can you gain a retern greater than that cost of capital if you invest the lump sum on your own!!!

[quote]mactuary wrote:

The lump sum and the annuity payout are actuarially equivilent. This means that the present value of the two payment streams is equal. (note that a lump sum is a payment stream of only one payment) If you think you can invest the money better than the interest rate used to perform the calculation and believe that the current tax environment is more favorable than the future tax environment, take the lump sum. Otherwise, take the annuity.

"only $15M"? still sounds pretty good for a lifetime investment of even $10,000 in lottery tix.

[

I'm not trusting the govt. to hold my money for me over the next 30 years. They can't even guarantee us our Social Security. I'm sure as hell not going to trust them to pay me my lottery money. I know, federal govt. run SS, but state govts. are just as inept if not more so.

I'd take my cash now and RUN. If you can't make it on 117 million dollars now, 350 million over 30 years sure ain't going to do you any good.

Reality is they'll be broke in a few years. Here's a few tales of the lives of lottery winners. Of course, its possible they could handle their money wisely, but the demographic that plays the lottery heavily usually isn't populated with great money managers to begin with:

http://money.cnn.com/2002/05/08/pf/saving/q_gonebust/

From the article linked above:

As it turns out, Post is in good company among lottery winners gone bust. One New Jersey woman even won two lotteries -- for a total of $5.4 million -- but blew threw it all on spending, gifts and gambling. Uncommon? Not really.

Two out of three lose or spend all their winnings within five years, said Stephen Goldbart, co-director of the Money, Meaning and Choices Institute in San Francisco.

Most lottery winners spend all their winnings because they don't make careful plans to save or invest it, he notes.

"The average American lives paycheck to paycheck," he adds. "So when they come into sudden wealth, they have to learn the financial ropes" of planning.

So here is something for the "What I have learned this week from letsrun."Americans are fat AND stupid.ALSO - would you rather have $4 million dollars or 1 penny doubled everyday for 30 days (ie 1, 2, 4, 8, 16, etc)

Zat0pek wrote:

Two out of three lose or spend all their winnings within five years, said Stephen Goldbart, co-director of the Money, Meaning and Choices Institute in San Francisco.

Most lottery winners spend all their winnings because they don't make careful plans to save or invest it, he notes.

"The average American lives paycheck to paycheck," he adds. "So when they come into sudden wealth, they have to learn the financial ropes" of planning.

[/quote]

dukerdog wrote:

According to my calculations you'd have a little over a billion if you invested 12 million a year for 30 years at 6.5%. I think you'd have to manage about 12.5% return before the lump sum comes out ahead. The payments stop upon death is the killer, so to speak. If that's true I would probably take the lump sum myself.

Your calculations are faulty because you'll collect a lot less than 12 million every year due to an income tax bite of up to near 50%, depending on state of residence.

Please revise your calculations using 7 mil/year and include the tax bite on the investment earnings as well.

The annuity doesn't pay out the same value each year. You get a smaller chunk in year one and it balloons up in value so the last payment you get is the biggest. I don't know the rate of the payment growth, but this should be taken into account in your lump sum / annuity comparisons.

Also, you can pass the annuity on as an inheritance, I believe.

Also, people that are worried about the government renegging on the payments: I think I read that the Powerball buys bonds that ensure the payout over the next 30 years, so there is no chance of this happening.

Then move offshore or to a state like Washington that has no state income tax. With that sort of money, you should hire a tax attorney or two to exploit every loophole in the tax codes to your advantage.

Present Value of Future Cash Flow Analysis:

Scenario #1 - Lump Sum of $120 million after tax

Assumptions:

Investment Rate of Return - 6.5%

Disount Rate - 4.5% (30-Year T-Bond)

Taxes - 50%

Result:

Present Value of Interest Cash Flow (30 years) - $63.53 mil

Present Value of $120 remaining investment @ 30 yrs - $32.04 mil

Combined Present Value - $95.57 million

Scenario #2 - $365 million paid over 30 Years

Assumptions: Straight-line annuity

Discount Rate - 4.5% (same as above)

Taxes - 50% (same as above)

Result:

Present Value of 30 Year annuity - $99.09 mil

Summary:

Based on these scenarios, it appears that an average investment rate of 6.5% results in an approximately equal present value between the two options.

Another poster stated that the annuity is not straight-line, as assumed in my calculation. I assumed straight-line, as I did not know the rate at which the annuity payments would increase. The impact of this would result in a lower Present Value on option #2, as payments in later years are worth less than payments today. If the annuity's cash flow stream is weighted toward later years (lower values), this obviously lowers the overall present value of the option. Due to this, the difference between the two scenarios is smaller than presented above, which is why I indicate the scenarios are approximately equal. Without knowing the exact rate of annuity payments increases, this statement is admittedly a leap of faith, but I think it is reasonable to assume the impact would be not much greater than the $3.5 million difference between the scenarios.

Running some quick calculations if you can average above 4.4% on your investments, assuming 35% tax rates, you are better off with the lump sum. I looked up the annuity payment growth and it starts at about 1.8% of the jackpot and grows at a rate of 1.04% each year.

The $120mil lump payout is already pretaxed. And I'm not including taxes on your investment income because that isn't paid until you sell the investments. I did however include taxes on those investments you sold each year to spend. I was assuming you spend $1mil per year. Which seems pretty ridiculous, but with that kind of money, who knows?

You people are a bunch of idiots:

1. The max federal income tax rate this year is 35%.

2. If you buy the lottery ticket in the same state as you reside, those lottery winnings have 0% state income tax.

3. If you choose the annuity and died before you collected all installments, then the remainder would pass onto your estate.

No wonder so many of these lottery winners blow their money in a couple of years - they must think like most of you!

Do you really get to decide which option to take? I thought you have to make that election when buying the ticket. You either ask for the Powerball annuity, or it just defaults to the cash option.

No. They changed it so you decide after you win.

My point was that at the time of initial disbursement, the two are actuarially equivilent - if you think that you can invest it better than the interest rate used for the calc, take the lump sum - tax implications come into play as well, but the lump sum is calculated as the present value of the annuity.

To the guy who made the Excel crack: When explaining a process using a tool that not all may be familiar with, giving "easy to follow" directions is better than giving the most efficient ones. If someone new to the area asks for directions, you give them the easiest route, not the fastest.

Idiots on this board wrote:

You people are a bunch of idiots:

1. The max federal income tax rate this year is 35%.

2. If you buy the lottery ticket in the same state as you reside, those lottery winnings have 0% state income tax.

3. If you choose the annuity and died before you collected all installments, then the remainder would pass onto your estate.

No wonder so many of these lottery winners blow their money in a couple of years - they must think like most of you!

I think #2 is wrong. I was scanning an article on taxes on the Powerball and it listed about 7 states that exempt you from state taxes on the winnings. The other states, I assumed, would still assess taxes.

"I looked up the annuity payment growth and it starts at about 1.8% of the jackpot and grows at a rate of 1.04% each year."

Where did you find that information?

Secondly, for everyone here, the annuity is for 29 years not 30. There are 30 payments, the first one being on the 'zeroeth' year.