Lump Sum vs. Annuity: A Guide to Massive Cash Payouts
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by: Ashley Donohoe, a Certified Financial Literacy Professional℠ (CFLP®) with 15 years of financial writing experience.
edited by: Doug Garfinkel
So, you lucked out and won that big jackpot we all can only dream of. I wouldn’t blame you if you were ready to live it up. I’d go shop for a new home, visit my friend in Argentina, and do much more. But don’t forget an important decision. Do you take all the money all at once or go with yearly payments?
While this might sound complicated, it’s not that bad. I’d even say it’s a good problem to have. You’ll just need to know how these payout options affect the actual cash you’ll get and the always dreadful tax bill. Let’s look at how the lump sum and annuity payout options for big cash winnings work so you can see which is the likely smarter choice for you.
The Lump Sum Isn’t All That It Seems
Most people go with the lump sum option for good reason. The simplicity of getting all your money upfront to do with it whatever you want is appealing, plus you can invest it to make it grow..
For you, that might be paying off your family’s debt, buying your dream home far away, and quitting that stressful job with the long commute for good. You can also take the money and invest it in an annuity or other relatively safe vehicle so it grows over the same period that you would get paid with the annuity option.
But some bad news is you won’t get the huge amount advertised. Instead, you’ll get a lower “cash” payout, often half or less of the full prize. And that’s before the tax man wants his cut.
Let me give you an idea. Powerball says its big $118 million Powerball jackpot is really only $53.7 million as a lump sum. Ok, that’s still some big bucks that I sure wouldn’t complain about. But it’s also around 55% less money.
And then it gets even smaller since Uncle Sam and your state want their share of your winnings. This is especially painful when you take all the money at once, since the tax agencies will treat it as income in the same year.
Upfront, the IRS will require withholding 24% of your cash jackpot, though your federal tax rate could be as high as 37%. So, don’t be surprised if there’s a bill when you file. Then, you’ll owe whatever taxes your state requires. So, that lump sum starts dwindling pretty fast. On the other hand, there’s predictability, though, since you get taxes out of the way quickly.
The Annuity Is Less Exciting, But Safer
A lot of people don’t want to drag out receiving their jackpot. If you go with the annuity option, you’ll get just one payment immediately, and the rest of your jackpot is paid out once per year for 30 years. Since this requires patience and keeps a big portion of your winnings locked up, it’s not surprising that it’s so unpopular.
But this “boring” option can also really pay off since your payments over those three decades will total the real jackpot amount. Each year, the payment usually increases to account for how inflation takes away from your money’s value over time. This means your largest payment is likely your last, while your smallest is likely your first.
Taxes also work differently if you choose the annuity route. Whether that’s good or bad depends on your situation and how your tax rates change over the years. One thing is that you’ll only pay taxes on the payment you actually receive each year. That saves you the shock of a huge tax bill at once
But then it’s less clear. Maybe you’re lucky and have a lower tax rate later, especially when the biggest payments come in. But unfortunately, we never know what will happen with taxes. If your tax rate hikes or varies, you could be in a tough spot some years. And don’t forget that these winnings are considered income. So, expect a much bigger tax bill simply for getting the bigger payout over time.
So, What’s the Better Option?
I wouldn’t immediately assume either was better by looking at the prize numbers. Sure, $118 million over time with spread-out taxes might look much more profitable than $53.7 million at once with a huge tax bill. But a change in your tax rate and missed investing opportunities can make it look not so great after all.
Then there’s your personality. Taking the lump sum can be a bad move if you overspend on things. Plenty of big cash winners have found themselves bankrupt despite winning millions. So, I’d say the annuity is safer considering that. The smaller payments over many years kind of take away some of the risk.
Also, consider the tradeoff in flexibility. The annuity isn’t so great if you have a big expense that can’t wait until the next payment. You can easily be out of luck. But if you take the lump sum and don’t blow it, you’d have something to tap into for life’s unexpected.
I’d also think about this if I were older. Sure, those I left behind could get the rest of the money. But I’d probably prefer enjoying it while I’m still here.
What I Would Recommend
I can’t make the decision for you. But I’d recommend taking it all at once if:
- You have an actual decent plan for the money.
- You’re someone who controls their spending.
- You need flexibility because of your age or finances.
- You’re OK with the smaller winnings.
- You’re sure you can manage that sudden big tax bill.
On the other hand, I think an annuity payout may make sense if:
- You want the biggest prize possible.
- You’re worried about wasting the huge payout.
- You don’t have any huge purchases planned in the near future.
- You’re younger, already financially stable, or otherwise don’t need much flexibility.
- You’ve done the tax math and don’t worry about higher rates later.
Don’t Make This Big Decision Alone
Being a big cash prize winner could put you in a tricky (and even unsafe) position. It’s scary how it’s so easy to get caught up in the excitement. You have to worry about both your unwise choices and people taking advantage of you. That’s why I advise against rushing your choice, especially if you don’t get guidance.
It’s imperative that you talk to financial advisors, lawyers, and tax experts. That way, you’ll know how the numbers add up and what tradeoffs there are. Also, ask how to make your payout work for you, how to manage taxes and how to best invest so that your winnings work for you for the rest of your life.
Frequently Asked Questions
What’s the biggest mistake big cash winners make?
Many don’t have a good financial plan and end up blowing their winnings. They also underestimate how much other people will take advantage of their luck.
What are smart things to do with a big cash payout?
While treating yourself is fine, it’s smart to pay off debt and invest some of your money. Talk to financial professionals who can recommend the best moves.
Does the lump sum or annuity payout option give me more money?
The annuity payout gives you more money, specifically the advertised jackpot amount. The other option means getting around 40% to 50% of that.
Ashley Donohoe is a personal finance educator with over 15 years of writing and editing experience. Whether she’s covering complicated tax laws or investment strategies, Ashley is skilled at breaking down complex topics with practical examples. Ashley holds multiple financial education certifications, including the Certified Financial Literacy Professional℠ (CFLP®) and Certified Financial Education Instructor (CFEI®) from the National Financial Educators Council. She also earned the Financial Planning & Wealth Management Professional℠ (FPWMP®) credential She’s an IRS Annual Filing Season Participant and holds the Uniform Tax Certification. Her work has appeared on major websites, such as The Independent, CNN Underscored, MarketWatch, FinanceBuzz, Car and Driver, GoBankingRates, and Money.com. Ashley holds a B.S. in Multidisciplinary Studies and a B.S. in Accounting and Data analysis from Liberty University, and an M.B.A. from Western Governors University.
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Sources:
Megamillions: how to play:
https://www.megamillions.com/how-to-play/difference-between-cash-value-and-annuity.aspxhttps://ialottery.com/Pages/FAQs/FAQ-Jackpots.aspx
How do lottery payments work:
https://www.gdblaw.com/resources/how-do-lottery-payments-work
Winners Guide from PA Lottery:
https://www.palottery.pa.gov/PaLotteryWebSite/media/PDF/PAL_Winners-Guide-Brochure_English.pdf
A Recommendation from Northwestern Mutual Life on what big cash winners should do:
Megamillions jackpot history:
https://www.megamillions.com/jackpot-history
A guide to selling lottery payments:
https://www.powerball.com/https://www.annuity.org/selling-payments/lottery/
How to claim a lottery prize: