Do you have some money coming your way, and do you need to decide if it would be more beneficial to accept that money in one lump sum or through a monthly/yearly annuity? If you are in the position of making this decision, you understand that it is a serious one. It is also a topic that has recently made the news.
At the end of March, the Mega Millions Lottery Jackpot reached a half billion dollars, prompting ABC World News with Diane Sawyer to cover the subject of lump sum vs. annuity payments. They interviewed economist Austan Goolsbee, a professor at the University of Chicago, who explained how lump sums are determined with the lottery. According to Goolsbee, lotteries fund themselves with zero coupon bonds. This is a type of bond that will reach the full amount of the award by its final year. If you take a lump sum, the amount you receive is what the bond is worth today. As interest rates go down, the bond value goes up. Because interest rates are currently low, the initial value of those bonds is much higher.
A recent article from U.S. News and World Report echoes this concept, stating the value of the lump sum plays a big role in if you should take it. They suggest you obtain your lump sum offer, and then compare it to the amount you would receive over time with annuity payments.
Let’s take the lottery example. If you won a half million dollars and took a lump sum payment, you would receive 359.4 million dollars today. If you took the annuity of $19,250,000 each year for 26 years, you would receive the full amount of the prize. However, this is pretax. The lottery withholds 25% for federal taxes, and then your state will take its share, which will be another 6-9%. So even though it appears you would be receiving less money by taking the lump sum, it could balance out if taxes increase over time. Additionally, taking the lump sum now would provide you with the opportunity to invest the money your own way, which could mean more money for you in the long run.
When making this important decision, you should weigh your health, your investment abilities, and your risk tolerance, among other factors. Consulting with a financial professional would be best as your weigh your options.