Powerball jackpot winners have two options when it comes to collecting their prize -- a lump-sum cash payment that's less than the advertised jackpot, or an annuity that spreads the entire prize out over a 30-year period. There are benefits and drawbacks to each option, so here's how the Powerball annuity works, and how to determine which option is the smarter choice for you.
How does the Powerball annuity work?
If a Powerball jackpot winner chooses the annuity option, they will receive an immediate payment, and additional annual payments for the next 29 years, for a total of 30 payments. In order to keep up with the cost of living, the annual payment is increased by 5% each year. The total of all 30 payments will add up to the total jackpot amount.
Here's an example of how this works. As I write this, the current estimated Powerball jackpot is $83 million, with a $52.8 million cash value. This means that a winner could choose between an immediate $52.8 million cash payment, or they could allow Powerball to invest the cash amount in an annuity, which would produce a total prize of $83 million paid over 30 years.
Using an annuity calculator, this jackpot would result in an immediate payment of $1,249,269. In the second year, this would rise to $1,311,733, and would continue to grow by 5% each year until a final $5,142,161 payment is made in the 30th year. This would result in a total of $83 million paid over the 30-year period.
It's also important to mention that the Powerball annuity is an "annuity certain," meaning that the payments are still made if the winner dies before the 30th year. In this event, the remaining payments would go to the winner's estate, and would pass on to their heirs.
Should you take the lump sum instead?
Most Powerball winners choose to take the lump-sum cash payout, but there are certainly good arguments to be made for both options.
With the annuity option, you have a guaranteed, inflation-protected stream of income for three decades. We've all seen the stories about lottery winners who end up going broke in a year or two, and the annuity effectively eliminates that possibility. In other words, choosing the annuity protects you from yourself, and from long-lost friends and relatives asking for money.
Taxes are another consideration -- with the annuity option, you'll only pay taxes on the money as you receive it. With the lump-sum, you'll pay a massive tax bill when you get the money, plus you'll pay taxes on your investment gains (such as dividends, capital gains, and interest income) every year if you invest the prize.
On the other hand, the cash option gives you the flexibility to do whatever you want with the prize money, right away. If you want to use $20 million to buy a few vacation homes, you're free to do so. Also, nobody knows what the top federal income tax rate will be in the future. The current 39.6% rate may sound high, but when you consider that the top rate was 70% in the early 1980s, it doesn't look too bad. The lump-sum option lets you lock in the current tax rate and eliminates the uncertainty of future tax policy.
There's also a solid argument to be made that by choosing the lump-sum and investing it yourself in a properly allocated portfolio of stocks and bonds, you can achieve far better returns over the long run than the Powerball annuity would produce.
The bottom line is that there's no one-size-fits-all option, but with all of the stories of broke lottery winners, maybe more people should give the annuity option serious consideration.