Powerball jackpot: Lump sum or annuity projection produces surprising result
A hypothetical financial model gives a slight edge to the lump sum
The winner of Tuesday’s multi-billion Powerball jackpot is facing a ginormous decision — whether to choose the cash or annuity option. Either choice comes with a huge tax bill.
Most winners chose to take the cash, and swallow a 37% federal tax rate, and any state taxes. In fact, according to Axios, no one has taken an annuity since 2014.
However, independent financial planner Adam Soloff of Warminster, Pennsylvania ran a financial projection for FOX Business and found total wealth, after accounting for taxes, is fairly close.
"It's surprising, it's almost neck-and-neck," said Soloff, a certified financial and tax planner. "A lot of the years, it's very close to a break even."
His projection found under one scenario, the investor who chose the lump sum option would end up with $2.68 billion in wealth in 2051 versus $2.44 billion from taking the annuity, a 9.8% difference,
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Soloff’s model used a 5% growth rate. He also gave the winner two houses worth $5 million and an annual spending budget of $2 million, numbers that are typical of his high wealth clients. Soloff cautions that his model doesn’t account for everything, including state taxes. However, the results surprised even him. He said a 5% return is the most conservative "worst-case scenario" and that client returns typically fall between 7% to 11%, depending on the level of risk a client is willing to take.
"Most financial planners advise taking the cash option," he noted. He leans toward the annuity. "The numbers are very close and with the added benefit of not having to worry about making any catastrophic mistakes with your money, the annuity, I think, is what I would recommend."
Top tax bracket
Hector Solis holds up lottery tickets purchased with his co-workers for the Saturday drawing of the Powerball lottery at the Bluebird Liquor store in Hawthorne, Calif., Sat., Nov. 5, 2022. (AP Photo/Damian Dovarganes / AP Images)
Soloff says taking a cash payment would leave you with $827 million after federal taxes compared to 30 regular payments of approximately $42.84 million each after taxes, or $1.29 billion before any investing.
Taxwise, a lump sum payment immediately puts you in the top bracket, whether you file single, head of household or married. Then there’s state taxes to worry about, if you live in a state with an income tax.
For tax year 2022, the top federal tax rate is 37% for:
- Single and head of household filers with incomes greater than $539,900.
- Married couples filing jointly with income greater than $647,850.
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Tax laws change. In fact, many provisions under President Donald Trump’s 2017 Tax Cuts and Jobs Act expire at the end of 2025.
Tax rates might come down in the future. Along with Trump, presidents John F. Kennedy, Ronald Reagan, Bill Clinton and George W. Bush and Barack Obama all cut taxes. Should you take an annuity in hopes that tax rates will be lower in the future?
Soloff says investors should not bet on future tax rates or stock market projections when making financial decisions. Those things are unpredictable.
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Cushion against catastrophe
Traders work on the floor at the New York Stock Exchange as the Federal Reserve chairman Jerome Powell speaks after announcing a rate increase in New York, Wed., Nov. 2, 2022. (AP Photo/Seth Wenig / AP Images)
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An annuity does remove other types of unpredictability. Soloff says a winner receiving regular payments would have a cushion against catastrophe knowing they are getting a guaranteed steam of income.
Someone taking a lump sum could lose their fortune in a bad investment or some other unforeseen circumstance.
Additionally, taxes would be withheld from each payment. It may not cover the whole tax bill, but it will reduce the amount owed at tax time.
Ultimately anyone winning a Powerball jackpot should seek professional financial advice before choosing either the cash or annuity option. Every person’s financial situation and needs are different.
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Soloff says a financial planner will account for a client’s needs and wants and show how each change affects the ultimate outcome. A plan would show how much less wealth you would have by spending money now, for example, by buying a luxury car. A client can then decide whether the trade-off is worthwhile.
"It's easy to get emotionally caught up in this. If you make it quantitative, we find that typically ends up with the best results," Soloff says.