Guide: Annuity or Lump Sum - Which Is Better?

If you win the US Powerball or Mega Millions, one of the decisions you will have to make is whether to take the prize as a lump sum or as an annuity. Both options have their pros and cons, and the decision will depend on your personal financial situation and goals.

Definitions:

• Lump Sum: A lump sum is a one-time payment of the total prize money. This option gives you access to all of the money (minus taxes) right away.
• Annuity: a series of payments made over time. The winner receives a fixed payment every year for a specific number of years - e.g. $1,000,000 a year for 30 years

A Basic Example:

Let's say you win $100,000,000 (congratulations!)

The gross payouts (before taxes - more on that below) are as follow:

You Win	Lump Sum Payout (Gross) You Would Receive:	Annuity Payout (Gross) You Would Receive:
$100,000,000	$52,000,000	$100,000,000 (As $3,333,333 a year for 30 years)

Now, Include Taxes:

Again, the below are based on $100,000,000 winnings.

For the example, we have used Michigan which has state taxes of 4.25%. To see if your state has additional taxes for lottery winnings see our guide.

	Lump Sum	Annuity
Gross Payout	$52,000,000	$100,000,000
Federal Tax (24%)	-$12,480,000	-$24,000,000
State Taxes (4.25% - Michigan)	-$2,210,000	-$4,250,000

So, overall, you receive almost twice as much money if you opt for Annuity over Lump Sum.

That sounds pretty great, right?

However, the money savvy folk out there will realise the annuity is actually a terrible investment!

Lump Sum Payout Wisely Invested

The Annuity option is essentially the lottery operator (Powerball or Mega Millions) investing your money for you and expecting a certain return. So, why not take the money and do the investing yourself?

For example, if you were to take the Lump Sum payout (after all taxes) of $30,589,668 and put it into investments (Stocks & Shares, Real Estate, etc) and get a 5% annual return, after 30 years it would be a massive: $132,206,782.37! See the compound interest calculation here.

Annuity (Net Payout After 30 Years)	$59,940,040
Lump Sum (Initial Net Payout)	$30,589,668
Lump Sum (Initial Net Payout Invested for 30 Years at 5% Return)	$132,206,782

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To visualize the above data in a graph:

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Now, it’s clear that the Lump Sum is by far the better choice if invested wisely - you could be over $70,000,000 better off than the annuity option!

Plus, once you have invested assets (Stocks, Real Estate, etc), you then have more options regarding when you draw the money - you can decide to spread it out over more than 30 years if you want. Also, you can gift assets to your children or leave in your will.

Caveats

Obviously, there are a few caveats to our example above:

1. You will no doubt want to spend some of your winnings so you are unlikely to invest all of your lump sum payment.
2. A 5% return isn’t guaranteed on investments. Investments can go down as well as up. We would recommend consulting with a financial advisor for professional investment advice.

What Would We Do?

It would really come down to the individual - how urgently they need the money and also how good they are with money. If they feel like they can’t trust themselves with a large lump sum to manage then the annuity would make sense. However, we would always try to take the lump sum and manage the money with the help of a financial advisor.