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3 Crucial Decisions You'll Face When Claiming Lottery Winnings

By Nicole Seghetti - Apr 5, 2013 at 4:15PM

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Don't forget to take these steps when claiming lottery winnings.

Many lottery winners, like Pedro Quezada, our inspiration for this article series, are average joes with no experience handling huge sums of money. So, assembling a professional team is critically important. They can help you with the three huge considerations you'll face in claiming lottery winnings.

Whether to take a lump sum or annuity. Prize money can be taken all at once or divvied out in annual payments over many years. If you choose the lump-sum option, you'll receive less money than if you take annual payments. I know, it seems unfair. But this is because lottery officials take into account the time value of money and make a net present value calculation to come up with the immediate lump-sum dollar amount. You only receive the advertised jackpot amount (in hard dollars) if you choose the annuity option. Because Quezada chose the lump-sum option, instead of 30 annual payments totaling $338 million, he'll actually receive $211 million before taxes.

While you may like the control that the lump-sum option gives you, be honest with yourself regarding your past money behaviors. People who have trouble controlling their spending may want to opt for the annuity option. It may save you from making poor financial decisions. Consult with your professional team regarding whether to collect the money in a lump sum or installments. Have them crunch the numbers and help you decide what's best for you.

How taxes affect your real payout. If you choose the lump-sum payout, you must pay taxes immediately on the entire amount. On the other hand, with an annuity, you're taxed annually only on the amount you receive each year. The money is considered ordinary income and taxed at the highest federal rate, currently 39.6%. Depending on where you live, you'll also have to pay state income taxes on that money.

Since recent Powerball winner and New Jersey resident Quezada has chosen the lump-sum option, his $211 million payout will dwindle to roughly $118 million after federal and state income taxes. 

How to invest the money. Even after you've settled up with Uncle Sam, you'll have a huge pile of cash. Put the money in safe, liquid, short-term investments, and get together with your professional team. Specifically, this is where a great financial advisor can add some real value. This individual can help you develop a holistic plan for how to invest your lottery winnings.

Investing the money is the best way to make sure it isn't sitting there doing nothing. After all, if your investments aren't returning more than inflation, then your money (even if there is a tremendous pile of it) is shrinking.

Keep a certain amount of your money in a bank account, but prudently invest the rest in the stock and bond markets. Diversify your portfolio, keeping a cap on risky investments. Don't invest in anything that can't be explained simply, that you don't understand, or that generally seems shady. If something sounds too good to be true, it probably is.

Most important, learn the financial ropes. Your money can grant you the time to become a knowledgeable and savvy investor, so occupy your days wisely. Take an investing class, read the great investing tomes, use online resources. Luckily for you, The Motley Fool can help! We give people like you the tools to become even better investors.

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