Millions of Americans play state and national lottery games each day. Some of these jackpots are worth hundreds of thousands, or even millions, of dollars. Winners of these big jackpots often have the choice of accepting the cash value payment or annual payments. Each selection has pros and cons associated with it. Choosing between the two options is a personal decision based on a number of considerations, including future tax increases, immediate financial need, age and investment plans, among others.
Most large lottery jackpots offer the cash value, or lump sum, option to winners. When opting for this choice, the winner is paid in one lump sum. The cash value payout of the jackpot is often much less than the advertised jackpot amount. Generally, it is estimated to be about half of the full jackpot amount. So if the advertised jackpot is at $100 million, the cash value would be around $50 million. The cash value is estimated by the starting cash amount of the jackpot, plus the proceeds of the tickets purchased for the specific drawing.
The second option for lottery winners is to take annual payments, or an annuity. This option pays the winner a set amount yearly until the total jackpot value is reached. Annual payments last for 20 to 30 years, depending on the lottery program. The annuity value is paid through government treasury securities -- bonds -- purchased using the cash value of the jackpot. Over the time frame of the annual payments, these bonds earn interest to make up for the difference between the cash value and the advertised annuity jackpot value. Some annuities are set up to pay out the same amount each year, while others pay different amounts.
Both the cash value option and the annuity option are subject to taxation. Generally, when a lump sum is paid, the tax will be paid up front. When annual payments are selected, the amount paid yearly will be added to the winner's income tax return each year and paid at tax time. There is a federal tax on lottery winnings, which is at least 25 percent and up to a maximum of 35 percent (at the time of publication). Not all states assess taxes on lottery winnings. The states that do assess a tax as high as 10 percent.
Each winner's choice between the cash value and annual payments is based on his personal situation. It is prudent to consult a financial planner when dealing with such large amounts of money to make the best decision. Take into consideration that tax rates are not set in stone and may increase or decrease over time. These rates would affect the tax owed on annual payments each year. Taking the annuity is worth more in the long run; however, investing the lump sum can have a greater earning potential over the same period of time if it is invested properly. Age is also a factor. Senior citizens may want to take the lump sum rather than payments over 20 or 25 years. Young winners may opt for annual payments There are also various companies willing to pay lottery winners lump sums when that option was not available to them through the lottery program. These companies would assume the annual payments owed to the winner in exchange for a lump sum payment. It is important to review the exact terms of the agreement and calculate the difference between the two options.