LUMP SUM OR THE ANNUITY: Here's which one to choose if you win the lottery

Business Insider
Jan. 13, 2016, 4:39 PM 64,761
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powerball lottery ticket
REUTERS/Mike Blake

The Powerball lottery is up to a record-breaking $1.5 billion.

We've taken a look into the point at which you should actually care about the Powerball lottery, factoring in the relationship between participation and jackpot size. But what happens when you actually win?

Normally the answer appears to be "take all the money up front immediately and subsequently squander every available penny on frivolous crap."

But what if someone won the lottery and then tried to handle it as rationally as possible?

We spoke to several financial advisers about how they would advise a client who came to them after hitting the jackpot.

The key question we wanted to know is whether a winner should take the all the cash up front or whether one should take the annuity, which consists of more money spaced out over several years.

But first, before we answer that we need to acknowledge the elephant in the room, which is the impact of taxes. We spoke to Clarence Kehoe, a partner at Anchin, Block & Anchin who chairs their tax department.

Clearly, Uncle Sam is going to want a healthy chunk of those winnings.

"Given the significant size of this lottery prize," Kehoe told Business Insider in an email, "the recipient will be in the maximum income tax bracket on their receipts no matter if they take a lump sum or take an annuity over 30 years."

So the multimillion-dollar question is what that top tax bracket will do over the next couple of years. The maximum federal income tax rate for 2016 is 39.6%. "As we know tax rates are always changing," he said. "If you take a lump sum you are looking at a 39.6% rate. If you take an annuity over the next 30 years the rates will probably be very different when you receive each payment."

So people who expect that the top tax rate will decrease over time — or that the Flat Tax crowd will win — should take that annuity. People who think the tax rate will increase over time should take the lump sum, to get everything out of the way sooner.

Still, the federal taxation is only part of it. Which state you live in also makes a difference, whether it's high-income tax New York or no-income tax Florida.

"We don’t suggest that readers change their state of residency in anticipation of the possibility of winning the lottery," Kehoe advised. "Also it is pretty much impossible to change your state of residency on the day you win the lottery."

So why not take the annuity and kick it to Florida?

Well, Kehoe said you're still pretty much screwed.

"Some (but not all) states have a rule that when you move out, if you have income that was earned as a resident you will have to pay tax on it even if you move to another low or no income tax state. So the planning idea doesn’t always work – it depends upon your current state of residency. New York is one of those states which taxes 'accrued' but not yet paid income."