What is the difference? Will it matter?
Should you beat the odds, and find yourself a lottery winner, choosing between a lump sum and annual payments does make a difference, and depends largely on your personal needs and goals.
Basically, lump sum payout really means “one chance payout”, whereas annual payout means “multiple chance payouts”.
Depending on the state and lottery rules, your payout option may be selected before or after your win. With either choice, you’ll pay federal taxes and in some cases state and local taxes too, according to the prize amount and your existing financial status.
With a lump sum disbursem*nt, lotteries pay out a percentage of the total jackpot in one lump sum (typically 40 to 50 percent of the full amount). If you select the lump sum option, you’ll receive a large chunk of cash for your immediate use. You may spend it 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 immediately 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, preferably from a Certified Financial Planner®.
The annual-payment option invests the value of the estimated present cash value of the 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. Annual payments give you less money that can currently be put to work in any one year. 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.
However, the annual-payment structure 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 and proper guidance, you will be able to create a solid estate as well.
In the end, determining which is better generally does not come down to a simple financial decision. It also needs to be a decision based on how well you know yourself, and those around you. If you lack the self-discipline to be a good steward of your money, or fear the constant pressure to spend from those around you, then perhaps taking your winnings in annual installments is a better option.
