By Mackenzie Hawkins
The Powerball jackpot swelled to an estimated $1.5 billion after no winner was declared in Wednesday’s drawing, nearing a record payout.
As Americans flock to buy tickets for the next drawing on Saturday, it’s a good idea to think about how you would manage that much cash in the extremely unlikely chance — about one in 292 million — that you win. It’s no small task, and inflation, interest rate hikes and a looming recession make it that much harder.
The lucky winner will have to choose between 30 annual payments that grow 5% each year and average $31.54 million after federal taxes, or an immediate cash payout of $745.9 million, which would drop to roughly $470 million after federal taxes. There’s argument for each strategy. But in the current high-inflation environment, financial advisors say a lump sum is the way to go.
“If you think about it, the annuity payment option is like buying a 30-year bond, and 30-year bonds have a lot of inflation risk,” said Noah Damsky, a principal at Marina Wealth Advisors in Los Angeles. “That’s a really concentrated risk to take when you have half a billion dollars after tax potentially coming your way.”
Lottery winners — like all investors — should pursue a diverse portfolio that includes fixed income, equities and alternative investments, Damsky said. The exact composition of that portfolio is “really a function of the person’s risk tolerance and their time horizon,” said Marguerita Cheng, chief executive officer of Blue Ocean Global Wealth in Maryland, adding that a lottery windfall is a great opportunity for impact investing as well as charitable or philanthropic giving.
Heavy Taxes
Right now, 5% growth in annual lottery payments falls far short of September’s 8.2% inflation headline. Still, opting to receive annual payments through 2051 would give the winner a much higher net payout, before any investment returns — and 30 times to try their hand at the market, preventing their winnings from evaporating after any one bad decision. On the other hand, taking a lump sum means a chance to build a diversified investment portfolio with greater returns each year than the standard 5% annual bump.
Either way, the windfall is heavily taxed: The federal government takes 37% — because the winner would move into the highest income tax bracket — and state and local rates vary, from no lottery taxation at all in some states, like California, Florida and Texas, to 10.9% in New York, with an additional 3.9% tacked on for New York City residents.
“I think the bigger question is, do you want to pay all the taxes up front or each year?” wrote Eric Kazatsky, senior US municipals strategist at Bloomberg Intelligence, of the decision between a lump sum or annuity. “At these rates I would want to pay the taxes up front and lock in long-term exempt rates.”
That would mean opting for the immediate cash payout and then investing it in a tax-exempt security like municipal bonds. This year’s economic headwinds have boosted 30-year yields on AAA-rated bonds to 4.08% — and for in-state buyers, none of the interest earned on the bonds is taxed at the federal or state levels.
Theoretically, investing the $745.9 million cash payout for 30 years at a 4.08% rate would bring your earnings to an estimated $1.66 billion. Even at $470 million, the return would make the winner a billionaire.
(Updates with federal taxes in third and final paragraphs.)
More stories like this are available on bloomberg.com.
