How Would You Take the Powerball Winnings?
January 14, 2016What would you do if you won yesterday’s $1.5 billion Powerball jackpot? Before you start thinking about how to spend a billion and a half dollars, understand that you won’t get it all at once. Instead, it’s paid out in 30 installments over 29 years. If you want the money now, you only get $930 million. Then there’s taxes.
So what would you choose? This article in the New York Times suggests that most people would be better off taking the installments. That’s because the return on your money while you wait to collect it is 2.843%, which is actually a pretty good deal right now for an essentially risk-free investment. Second, the taxes on that interest are deferred until you actually collect the payment.
But the biggest threat to your new wealth isn’t from Uncle Sam. It’s from you. That’s why so many lottery winners go bankrupt and why the final and most important reason to defer the payments is to prevent you from risking it all in a crazy investment scheme or giving it away to newly discovered relatives that you didn’t even know you had.
This may seem like just a fun thought experiment but it’s similar to the choice many people face when they’re given a choice of a lump sum pension payout or an annuity paid out over their lifetime. Even if you don’t have a pension, you’ll have to decide what to do with your nest egg when you retire. Do you keep the money invested and make withdrawals or purchase an immediate annuity?
Let’s look at the numbers. If you took the installment payments of $50 million a year, you would get about about $30 million each year after paying the top 39.6% federal income tax rate. That’s a total of $900 million over 30 years.
If you took the lump sum, it would be worth about $562 million after taxes. If you had invested it in a simple portfolio of 60% stocks and 40% bonds and withdrew the same $50 million a year starting 30 years ago, you would have over $700 million today. (Plus part of that $50 million would be subject to a lower capital gains tax rate.)
Of course, this assumes that the next 30 years looks something like the last 30 years but even if you ended up with half as much money at the end, you would still be much better off. More importantly, it also assumes that you can stick to the same simple and timeless principles as you should follow with any money you invest for retirement:
1) Diversify.
2) Keep investment fees and trading costs to a minimum.
3) Don’t withdraw too much for income.
4) Stick to your plan though thick and thin.
If you can do that, you’ll likely be better off with the lump sum. If not, stick to the annuity. You might make money chasing the latest investment fad, but I certainly wouldn’t bet on it.