How does a lottery annuity work?
Learn how a lottery annuity works, how it differs from a lottery lump sum and its tax implications.
Matching the lucky numbers in a lottery can be a life-changing experience. One of the immediate questions, when someone wins a jackpot prize, is whether to take the winnings in a lump sum or annuity payments. The Annuity option guarantees a stream of income over a long time, but there are certain things you should keep in mind.
A lottery annuity comprises an immediate payment and annual payments that increase by a percentage each year. The number of periodic payments depends on which lottery you win. If you win the Powerball or Mega Millions lottery, you will receive 30 payments over 29 years. A lottery annuity protects winners from overspending their windfall by spreading payments over a long time.
What is a lottery annuity?
A lottery annuity is a payment option that is available to lottery winners. Popular lotteries such as Powerball and Mega Millions allow winners to receive payments either as an annuity or lump sum. If a lottery winner chooses the annuity option, they will receive the lottery prize in a series of annual payments spread over a specified period of time, depending on the specific terms of the lottery.
The main benefit of the lottery annuity is that winners receive a guaranteed stream of income over a long time. With many stories of winners who squandered their winnings all at once, the annuity option may be beneficial for winners who are not prepared to handle an unexpected windfall. If the winner squanders the payment received during the year, they can wait until the next payment period to receive the annual payment.
However, one of the shortfalls of a lottery annuity is that the winner does not have control over the investments. The lottery organization is responsible for investing the money and making annuity payments, and the winner has no control over how the money is invested or the returns earned.
How does a lottery annuity differ from a lump sum payment?
An annuity and a lump sum payment are the two options that lottery winners have to receive the prize. These payment options differ in how prize monies are received.
When a winner chooses to receive annuity payments, they will receive a series of payments over a specific period of time. For example, the Mega Millions lottery annuity makes 30 annual payments over 29 years. Generally, the winner will receive an immediate initial payment and a series of annual payments over a set period of time. The total annuity amount is usually higher than the lump sum amount, but the annuity payments are subject to inflation risk.
A lottery winner can also choose the cash option where the lottery makes a single lump sum payment. Generally, the lump sum amount is less than the total amount of the annuity, but the winner gets immediate access to the funds. The winner receives the reduced prize money at once, and they can spend it as they choose. The IRS will withhold 24% of the winnings for federal taxes, and the winner may owe additional federal and state income taxes, depending on their income tax bracket rate.
Can you sell a lottery annuity?
When you win the lottery and choose to receive a lottery annuity, you won’t be able to change the payment method. A lottery annuity spreads payments over a period of time.
However, some lottery winners may prefer to receive the prize as a lump sum payment instead of waiting for the annual payments over the specified period of time. In this case, the winner can decide to sell the annuity in exchange for an immediate lump sum amount. However, selling a lottery annuity can have some legal and financial consequences, and the winner should review the sale agreement to determine the terms of the transaction.
Additionally, some states may not allow after-market sale of lottery annuities. In states that allow after-market sale of lottery annuities, the lottery winner would be required to get court approval to proceed with the transaction. The court must determine whether the sale is in the winner’s best interests.
What happens to my lottery annuity when I die?
How the lottery handles your annuities when you die depends on the existing regulations of the lottery. Generally, popular lotteries like Powerball and Mega Millions allow lottery annuities to be passed on to the living beneficiaries of the owner.
Additionally, some lotteries may allow the transfer of payments only when the annuity owner dies. In this case, any remaining payments will be distributed to the living beneficiaries or the deceased's estate according to the annuity owner's will or state law.
In some cases, the lottery may cash out the remaining annuity payments and pay a lump sum to the estate. This makes it easier to distribute the deceased person’s inheritance among the heirs, and pay any federal taxes owed by the estate. However, an annuity cashout may only occur if the state where the ticket was purchased allows it.
Tax implications of lottery annuity payouts
The Internal Revenue Service (IRS) considers lottery winnings as gambling winnings, and they are subject to federal income taxes. The winner must report the lottery payments as income on their annual tax return.
If you receive lottery winnings as annuities, the tax liabilities are calculated based on the annual payments received, and not the overall winnings. You will pay taxes over time when you receive the annual payments. However, this creates uncertainty since the taxes could increase or decrease. If the taxes go up, you will keep less of your winnings; if the taxes go down, you get to keep more of your winnings.
On the other hand, if you choose to receive the lump sum option, you will pay federal and state taxes (if any) immediately. The windfall could push you to the highest tax bracket and pay up to 37% in federal income taxes.
In most cases, the lottery agency will withhold 24% of the annual payments for federal taxes, and you will pay any additional federal income taxes when filing the annual tax return. Also, depending on the state where you live, you could pay even more in state and local taxes. However, states like California and Florida don’t impose state income taxes on lottery winnings.