‘If people are going to blow it, they’re probably going to find a way’
Powerball fever has struck, and people can’t stop talking about the 1.5 billion jackpot that may go to some lucky winner(s) tonight.
But what’s the best way to take your windfall? This New York Times story getting a lot of attention on social media says that, for several reasons, taking the full $1.5 billion in annual annuity payments over 30 years is a better financial deal than taking the lump sum payment of about $930 million – not just because it’s more money from the lottery, but because the lottery’s annuity is a better investment overall than you can make yourself.
That’s the Times’ view. UMKC Prof. Nathan Mauck Ph.D. says, hold on just a minute.
A lot of the Times piece makes sense, said Mauck, an assistant professor of Finance at the Henry W. Bloch School of Management. But it is also based on a couple of assumptions that may not pan out.
For one, the Times states that there are tax advantages to taking the annuity option, because the investment income of the annuity is not taxed. But Mauck points out that the winner still pays taxes on each annual payout, and tax rates are subject to change. If tax rates hold steady or go down over the 30 year period, then the annuity remains the better option. But if taxes rise significantly over the next 30 years – and on annual payments in the neighborhood of $22 million, you’ll likely stay in the highest tax bracket throughout – the lump sum could end up as the better deal.
The article also assumes that the winner will pursue an ultra-safe investment strategy based on government bonds. Mauck said, however, that a different investment strategy would produce very different results. Investing the lump sum in a stock market index fund is risky, he said, but likely to return a better result over the long haul.
“If you’re going ultra-safe, the annuity makes a lot of sense,” he said, producing a rate of return a little under three percent. “Historically, the stock market over 30 years beats that three percent by quite a lot.”
Mauck, however, agrees with the article’s most salient point: that the biggest advantage of the annuity option is protecting the winner from making foolish investments and spending decisions in a short amount of time and losing a lot of money in a hurry.
“There’s definitely some safety in getting a certain amount every year,” Mauck said. “Although, if people are going to blow it, they’re probably going to find a way to blow it.”