If you won a lottery, would you choose to do a "lump sum cash payout" or "26 annual payment"?

It is important to understand how lotteries like Mega Millions and the Powerball conduct their payouts and why the difference between the announced jackpot and the "Cash Option" is so dramatic.

The large jackpot numbers are based on an annuity payout that is tied to current yields of US Treasury securities. The way they take - say - $14 million and turn it into $25 million distributed over 26 years is they purchase an annuity from an insurance company, specifically an immediate annuity, period certain, with a return of principal calculation. A portion of the 14 mill is used to buy 25 year bonds, a portion for 24 year bonds, etc. The higher the yield on Treasuries, the lower the amount needed to satisfy a given jackpot.

There have been volumes written on this question, whether it is better to take the payments or the lump sum. For many people, the payments are a better idea because most big money lottery winners have zero experience managing large sums, so if you screw up by over spending this year, just wait! You'll get another big check next year!

From a pure investment perspective, it is almost ALWAYS better to take the lump sum because it is actually pretty easy to beat long term Treasury yields if one is careful and if you can beat them by even one percent, you will come out ahead over the course of 26 years (29 with the Powerball). Finding a fixed annuity that will beat US Treasury rates is not difficult at all. Putting together a portfolio that has a growth aspect as well as the fixed income segment, even a very conservative mix, will do better than what the lotteries are going to provide.

As far as the taxation is concerned, if you take the lump sum then yes, you will pay the Federal taxes for the year right up front and that level is currently 35%. If you live in a state with a personal income tax (and 43 of them do), you will have to pay that too, all right up front. The math works out so you would end up with somewhere around a third of the announced jackpot as "take home pay" if you will, depending on your state income tax level. One advantage to taking the lump sum is you will be avoiding any potential increases in the higher marginal rates in the future. The highest marginal rate was over 90% at one time in the US. There is nothing stopping Congress from going back to such rates, though it is unlikely they will ever go back quite that high.

It has been said that 3 out of 5 big money lottery winners declare bankruptcy within 5 years and the horror stories of lives ruined or family troubles are easy to find with a simple web search. The largest single ticket winner in Powerball history - Jack Whittaker of West Virginia, has lost his marriage, his grand daughter died of a probable drug overdose and he has been arrested numerous times. Often large sums of money do not make problems go away. It magnifies them.

If I ever won a large sum, the first call would be to an attorney. I would take the lump sum, but I would not go collect it myself. I'd send the lawyer and he would collect it in the name of either an LLC we formed or an investment trust, NOT my name. I wouldn't call any of my friends or family members that I thought might spread the news around. I want the news to be as quiet as possible and I don't want my name or face in the press. People will show up at your door with all sorts of sob stories. You have to learn to say NO, or total strangers as well as family will bleed you dry. I would then basically disappear for twelve months at least. Take a trip around the world. Go rent a houseboat on a big lake, take train journeys - ANYTHING - just get away from your surroundings. Let the hoopla die down.

If you were to ever win a large sum, at the very least you are going to need a lawyer, as well as a CPA, perhaps a tax lawyer too, and most certainly professional counsel for the investments that will be made.

Either way you'll have to deal with taxes. The lump sums guarantees that it'll be taxed at a higher percentage rate even if it's in the same marginal tax bracket. I used to always select the cash value option because I like the idea of having the money to manage but if that's the premise then you're off to a bad start as you've only maximized the taxes on the winnings. If the Jackpot is sufficiently large then the annual payments will already be in the millions per year and the only reason to take a lump sum would be if you wanted to make investments that would likely leave you with greater expenses such as buying a multi-million dollar mansion without considering the annual property taxes, utilities, insurance or upkeep. If you took the Annuity, the first year's payment should be enough to make a significant change in your life anyways, the additional millions really wouldn't and you would have the opportunity to strategize how to deal with the rest of the payments in order to manage your money. Remember that the annuities are a security much as a bond is a security, you can always sell the annuity for the cash value option. The real question is how much is enough, it's the first million that will make the biggest impact in your life and both options will get that first million into your hands very quickly. The annuity will ensure that you will be able to take the time and plan how to manage the rest of the money as it comes in.

Yes, it is taxed "as" you get your payout.

If the cash payout is $5 million on a $9 million jackpot, you are going to get something north of $3.2 million after the tax withholding are subtracted (first).

I would take the cash payout, but I know how to manage money.

Most people (55%) should take the annual payments and never spend more than the payment in any one year. People who win or inherit large amounts of money most often end up in financial trouble because they confuse having money with understanding how to manage it.

in most cases it is taxed when you win, i would take all of the money up front even with it being less, take and invest and leave it alone and take what it makes

Get the payments because you get more from that in the long run.