If You Win The Lottery, Is It Better To Take The Lump Sum Or An Annuity?

You, quite literally, have a better chance of being struck by lightning than you do of winning the lottery. However, that hasn't stopped millions from buying tickets and dreaming about what they might buy, pay off, or even give away if they ever won the jackpot. However, in between the fantasy of real estate and paying off student loan debt, you might not have asked yourself how you would actually accept the winnings.

Typically, there are two main ways to collect lottery winnings, as a lump sum or through annuity payments, and there can be serious financial implications attached to whichever option you might choose. However, despite multiple factors that can change which payout option is best, one option remains decidedly more popular. Andrew Stoltmann, a lawyer for past lottery winners, told CNBC, "Virtually everybody who wins the lottery picks the lump sum distribution." Yet, despite the lump sum's popularity, it might not necessarily be the best choice. Stoltmann explained that "the typical lottery winner doesn't have the infrastructure in place to manage such a large sum so quickly."

Whether you're Team Lump Sum or you prefer the idea of receiving monthly or annual annuity payments, there's a lot to know and understand about each lottery-winning payout option. Beyond a thought exercise about what you'd do with such a windfall if you won, understanding the financial implications attached to either option can better prepare you in the event you ever beat the odds.

Taking the cash lump sum

A lump-sum payment is exactly as it sounds. A lottery winner can opt to collect the entire winning amount in one singular payment. This is the most popular choice that winners make. Which option works best for you can largely depend on your personal circumstances and even your age and health condition. While annuity payments can be bequeathed to family members in the event of a winner's death, winners without family or heirs might be better served by a lump sum. This can be especially true of older lottery winners who might not have 20 to 30 years of life left to collect their annuity payments.

However, while choosing a lump-sum payment gives you full access to your winnings all at once, there are some serious downsides to be aware of. Namely, the amount paid out in one lump sum will be lower than the advertised lottery prize amount, meaning you stand to lose a significant amount of your won prize money by choosing this payout option. For instance, the July 2022 Mega Millions jackpot for $1.025 billion only had a lump-sum payout of $602.5 million.

Another important consideration with taking a lump sum is that you'll be taxed on your full lottery prize amount in the year you win. This can have significant tax bill ramifications depending on your income and how much you win. Something to also keep in mind is that inheritances are generally not taxed, so passing on the (remaining) lump-sum amount in your will could benefit whoever ends up receiving your winnings.

Choosing the annuity instead

Annuity payments allow lottery winners to collect an initial payout, followed by smaller portions of their winnings over the course of 20 or 30 years. An important thing to keep in mind about opting for annuity lottery payments is that you'll be taxed on the payments during the year(s) you receive them as opposed to being taxed on the winnings in a single year like with the lump-sum option. Also, these payments are known as "annuity certain," meaning the payments are set for a certain number of years (unlike annuities that might end when the payee dies). This means you can bequeath the payments to someone else in your will for the remaining duration of the annuity agreement so that even if you're no longer around to enjoy the full 20 or 30 years of lottery payouts, your family can still receive the winnings.

Another consideration when deciding between a lump sum or annuity can be risk management. If you worry about spending money excessively or not being able to handle a large sum, annuities can safeguard against any impulsive financial decisions you might regret later. One of the particularly great things about the annuity route for winnings is that your annual payments go up every year. In fact, Powerball annuity payments are scheduled to increase 5% every year during the 29 years of your annuity payment plan, which means not only are you guaranteed to continue earning money passively, but you'll get what amounts to an annual raise as well.