Most lotteries allow the winner to take a lump sum or an annuity. The lump sum is a single cash transfer whereas the annuity is a series of annual payments. Most lottery winners, if given the choice, take the lump sum payment. They want all of the money immediately, and that is the main advantage. You have full and complete access to the money. The lump sum payment can have disadvantages, however.
First, if your lottery prize is less than $10 million, you may be in a better income tax position if you receive the proceeds over several years via an annuity rather than up front. Why? Lottery wins are subject to income tax in the year you receive the money. If you take the lump sum option, the entire $10 million is subject to income tax that year. However, if you choose the annuity option, the payments could come to you over several decades. For example, instead of $10 million of income in one year, your annuity payment might be $300,000 a year. Although the $300,000 would be subject to income tax, it would keep you out of the highest state and federal income tax brackets. (In fact, the 2018 tax brackets allow individuals to have an income of $500,000 a year – and those who are married filing jointly, $600,000 – and still be in the 35%, rather than 37% bracket.)
Second, I strongly believe that for certain people who are more prone to spending, won’t get help from advisors and/or have certain familial pressures, the lump sum option can create more problems. There are lots of lottery winners who you never hear about who do just fine, but there are others who ruin their finances, relationships and lives after they win. For them, having less access to the full amount of the win is better. Instead of having to manage $15 million, they may be much better at managing $800,000 a year.
The annuity is not as cool as a big check, but I’ve never heard anyone complain about receiving a check in the mail every year.
