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Author Topic: Good lottery luck can go bad fast
Troberg
Angels Wii Have Heard on High


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quote:
Then buy an island, move away and let the legal guys send you your interest...
That's more or less my plan, except going to work one last time, go into my boss' office and do a cover on 'Take this job and shove it, I ain't work here no more'.

And perhaps sic some laywers and/or mercenaries on a person or two I know...

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/Troberg

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Hero_Mike
Happy Holly Days


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The "public record" aspect of publishing names of lottery winners avoids the perception that the lottery is "fixed". Winners are random and publishing their names and pictures makes it legitimate - you could only have a conspiracy if nobody knew the winners.

On the other hand, it's also good advertising. The people who win often have a small biography printed with their announcement - makes people feel good that the winners announce their plans to retire, share the wealth with family, etc., because the next winner could very well be you.

I have long since believed that lottery winners are "coached" when giving their public statements. Nobody comes up and says "I'm never going to work again, not like the rest of you suckers!" That makes lottery winners look arrogant, nasty, and implies that wealth changes them. This is bad publicity.

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"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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guruwan2b
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I mis-spoke earlier about the year to claim (must have gotten that from that Nick Cage movie).
Here in OK it is 180 days, which still leaves you a lot of time to plan.

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Too much of this navel gazing and we'll disappear up our own arses.
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Rach
I'm Dreaming of a White Sale


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In Australia, lottery winners identifying details are not released unless the winner(s) do so themselves. Ie. the announcement can say age, location & outlet where the ticket was sold, but can't use names/pictures etc..

It stems from the Sydney Opera House Lottery. The winner's details were published in the newspaper, shortly after, his son was kidnapped/killed for ransom. The Opera House lottery was stopped and new laws made because of it.

http://www.thecrimeweb.com/murder_of_graeme_thorne.htm

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The Presence of an Intelligent Mind is one that can hold two opposing opinions at the Same Time.

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Errata
Happy Xmas (Warranty Is Over)


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There are too many famously rich people in the public eye. If psychos want to kidnap people, they have plenty of targets already.
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Electric Shadow
I'm Dreaming of a White Sale


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Most famously rich people have large gates and security staff. People who won the lottery yesterday, less so. They're an easier target.

Plus, there's sometimes a bitterness towards lottery winners. You often hear stories of people who think they're entitled to a share of the winnings because it was 'money for nothing', such as family, friends or complete strangers who send begging letters. This bitterness can easily translate into criminal behaviour.

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Hero_Mike
Happy Holly Days


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If you're talking about US lottery winners, the vast majority of them don't have enough money to pay a huge ransom because the lotteries are paid out as annuities because of tax implications. Win 1 million, and it's $50K per year over 20 years, minus taxes. Not a huge payoff available for ransom, so the risk vs. reward is just not there.

Those who hit the big win on Powerball, well, they will have the big money, but then again, they are more likely to protect themselves by withdrawing from public life. No guarantee, but risk vs. reward needs to be considered. Kidnapping is a serious crime.

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"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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Seaboe Muffinchucker
Let There Be PCs on Earth


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quote:
Originally posted by Hero_Mike:
If you're talking about US lottery winners, the vast majority of them don't have enough money to pay a huge ransom because the lotteries are paid out as annuities because of tax implications. Win 1 million, and it's $50K per year over 20 years, minus taxes. Not a huge payoff available for ransom, so the risk vs. reward is just not there.

Every lottery I'm aware of offers the option of a one time payment. It's much less than the $1 million, but enough to pay a small ransom.

Seaboe

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Education is not the filling of a hard drive, but the lighting of a bulb. -- Yeats via Esprise Me

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Hero_Mike
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quote:
Originally posted by Seaboe Melonchucker:
quote:
Originally posted by Hero_Mike:
If you're talking about US lottery winners, the vast majority of them don't have enough money to pay a huge ransom because the lotteries are paid out as annuities because of tax implications. Win 1 million, and it's $50K per year over 20 years, minus taxes. Not a huge payoff available for ransom, so the risk vs. reward is just not there.

Every lottery I'm aware of offers the option of a one time payment. It's much less than the $1 million, but enough to pay a small ransom.
I've seen 5.36% as the "discount rate" for lottery winnings, which puts a $1 million prize at just over $600K - *before taxes*. Assume that your other income that year is $40K - total income $640K. I looked up the tax rates and by my guess, you will pay just over $206K in US federal taxes on this amount. State income taxes vary by state, but average about 5%, or about another $32K. At the end of the day you are left only with $406K in your pocket, some of which is part of your other $40K of income. The net benefit is only $372K - for a prize that is worth $1,0000,000.

Few people will take this option, even though getting $400K up front may be appealing. On the other hand, the $50K per year annuity should leave you with about $37K of after-tax income per year, which over 20 years, is the much better deal.

My point is that because of the tax implications, few people will take the lump-sum payment on small lottery winnings, and the prospects for a ransom are extremely unlikely. Besides, how would you know - I don't know if the winners choice (lump sum vs. annuity) is a matter of public record.

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"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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Errata
Happy Xmas (Warranty Is Over)


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quote:
Originally posted by Hero_Mike:
quote:
Originally posted by Seaboe Melonchucker:
quote:
Originally posted by Hero_Mike:
If you're talking about US lottery winners, the vast majority of them don't have enough money to pay a huge ransom because the lotteries are paid out as annuities because of tax implications. Win 1 million, and it's $50K per year over 20 years, minus taxes. Not a huge payoff available for ransom, so the risk vs. reward is just not there.

Every lottery I'm aware of offers the option of a one time payment. It's much less than the $1 million, but enough to pay a small ransom.
I've seen 5.36% as the "discount rate" for lottery winnings, which puts a $1 million prize at just over $600K - *before taxes*. Assume that your other income that year is $40K - total income $640K. I looked up the tax rates and by my guess, you will pay just over $206K in US federal taxes on this amount. State income taxes vary by state, but average about 5%, or about another $32K. At the end of the day you are left only with $406K in your pocket, some of which is part of your other $40K of income. The net benefit is only $372K - for a prize that is worth $1,0000,000.

Few people will take this option, even though getting $400K up front may be appealing. On the other hand, the $50K per year annuity should leave you with about $37K of after-tax income per year, which over 20 years, is the much better deal.

Maybe, maybe not. That $37k is worth less and less every year in real dollars due to inflation, while the lump sum is potentially earning interest over that time period. I suspect they work out to be pretty similar in real value on average.

If you invest the lump sum at 7% a year, it would be worth about 1.4million. And thats being conservative, since historically, inflation alone over those 20 years will probably be an average of about 4% or so, and historically the stock market has done better than 7% over most 20 year periods.

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Seaboe Muffinchucker
Let There Be PCs on Earth


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According to the Washington State Lottery's audited financials for 2005, page five:
quote:
The amortization of annuity prize liability decreased... This moderate decline reflects the fact that single cash payments are now the most common method of payment for jackpot winners.
Seaboe

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Education is not the filling of a hard drive, but the lighting of a bulb. -- Yeats via Esprise Me

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Hero_Mike
Happy Holly Days


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quote:
Originally posted by Errata:
quote:
Originally posted by Hero_Mike:
quote:
Originally posted by Seaboe Melonchucker:
quote:
Originally posted by Hero_Mike:
If you're talking about US lottery winners, the vast majority of them don't have enough money to pay a huge ransom because the lotteries are paid out as annuities because of tax implications. Win 1 million, and it's $50K per year over 20 years, minus taxes. Not a huge payoff available for ransom, so the risk vs. reward is just not there.

Every lottery I'm aware of offers the option of a one time payment. It's much less than the $1 million, but enough to pay a small ransom.
I've seen 5.36% as the "discount rate" for lottery winnings, which puts a $1 million prize at just over $600K - *before taxes*. Assume that your other income that year is $40K - total income $640K. I looked up the tax rates and by my guess, you will pay just over $206K in US federal taxes on this amount. State income taxes vary by state, but average about 5%, or about another $32K. At the end of the day you are left only with $406K in your pocket, some of which is part of your other $40K of income. The net benefit is only $372K - for a prize that is worth $1,0000,000.

Few people will take this option, even though getting $400K up front may be appealing. On the other hand, the $50K per year annuity should leave you with about $37K of after-tax income per year, which over 20 years, is the much better deal.

Maybe, maybe not. That $37k is worth less and less every year in real dollars due to inflation, while the lump sum is potentially earning interest over that time period. I suspect they work out to be pretty similar in real value on average.

If you invest the lump sum at 7% a year, it would be worth about 1.4million. And thats being conservative, since historically, inflation alone over those 20 years will probably be an average of about 4% or so, and historically the stock market has done better than 7% over most 20 year periods.

No, definitely not the same "on average". The up-front value of the annuity is discounted by an assumed interest rate - in this case I used 5.36% - a figure I had on hand from some anecdotal analysis of the Powerball lottery from last year. In any case, to merely achieve the same dollar value, you need to invest the *whole* of your winnings and earn at least 5.36% of *after-tax* interest. Except that the tax structure is progressive, and this is where you lose out.

In my example, I used this data here for tax rates, assuming a single person. Let's assume you live in a state with no state income tax. Let's assume that you already (and continue to) earn a slightly above average $40K per year aside from your lottery winnings. The tax rate table shows that you pay up to 35% of your income - your lottery winnings - in taxes. That is a lot of money.

Your math may be correct, but your example is flawed because you assume that you pay no taxes on either the lump-sum winnings, or the 7% you earn each year in interest, which is also taxable. The example is also flawed because you do not allow for *any* of the prinicipal or interest to be spent along the way.

A more realistic example is like this - figure that a $50K per year annunity gives you $37K after taxes. Now assume that you want to maintain the purchasing power of this $37K, so you increase that by 2.5% per year, for inflation. That means that you have a series of payments that start at $37K in the first year, and just over $59K in the 20th year. Now, assume that you invest your *after-tax* lump sum prize of $372K, and each year, from the *after-tax* interest earned, deduct the same $37K (adjusted for inflation) you would make if you just collected the after-tax annuity.

In this example, I assume a tax rate of 28%, because you continue to keep a regular job and have that base income of $40K.

To get back to being even, assuming the 2.5% inflation and 28% annual tax rate on your investment, you need to earn a whopping 13.94% of before-tax interest. I'd like to see the stock-market do that for the next 20 years!

Even if you assume 0% inflation, you still have to pay that 28% tax on your investment income each year. That still requires over 11% of before-tax income on your initial investment.

Your big mistake here is that you forget that you need to pay taxes on your investment income, and while I may be wrong in choosing that 28% tax rate for investment earnings, the progressive tax structure is what penalizes the lump-sum option.

I happen to live in Canada, and this is all moot because lottery winnings here are all tax-free, and with the exception of a few "special" games which pay money every week "for life", lottery winnings are always lump-sum and at face value.

You also forget that most people are likely to have immediate needs for "found money" that include the immediate repayment of any debts, so even that initial amount available for investment will be reduced.

--------------------
"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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Errata
Happy Xmas (Warranty Is Over)


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Capital gains aren't taxed at income tax rates, they're taxed at 8-10%. A progressive 30% capital gains tax would certainly inhibit investment, and not just for lottery winners. 2.5% inflation is below average for extended periods of time, and inflation doesn't work against the lump sum option, it works in favor of it. And the median family income in the US in 2005 was $60k.
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Hero_Mike
Happy Holly Days


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quote:
Originally posted by Errata:
Capital gains aren't taxed at income tax rates, they're taxed at 8-10%. A progressive 30% capital gains tax would certainly inhibit investment, and not just for lottery winners. 2.5% inflation is below average for extended periods of time, and inflation doesn't work against the lump sum option, it works in favor of it. And the median family income in the US in 2005 was $60k.

I used the tax rates and income for a *single* person, simply because it includes fewer variables. I can run the numbers for any situation, but they will probably say the same thing.

Call inflation 4%. Make the capital gains tax rate 8%. You still need a before-tax rate of return of 12.45% to get that inflation-adjusted after-tax bonus income of $37K.

In this scenario, inflation is more overwhelming than taxes. If you assume zero inflation, you only need a before-tax return of 8.35%. It's a real "tea leaves and entrails" prediction for what inflation will average for the next 20 years, but it is the major assumption and unknown in all of this.

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"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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robbiev - singin' off key
Happy Xmas (Warranty Is Over)


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quote:
Originally posted by Class Bravo:
One of my favorite quotes of all time from The Onion:

"The Lottery. It's like a stock market for poor people."

I like this one:

"The lottery. A tax on people who are bad at math."

Don' know the source, though.

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Every time I see a good looking woman, I think, "0oooh. There's another one I'll never have!"

Corvette. The louder you scream, the faster I'll go.

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Seaboe Muffinchucker
Let There Be PCs on Earth


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quote:
Originally posted by Hero_Mike:
quote:
Originally posted by Errata:
Capital gains aren't taxed at income tax rates, they're taxed at 8-10%. A progressive 30% capital gains tax would certainly inhibit investment, and not just for lottery winners. 2.5% inflation is below average for extended periods of time, and inflation doesn't work against the lump sum option, it works in favor of it. And the median family income in the US in 2005 was $60k.

I used the tax rates and income for a *single* person, simply because it includes fewer variables. I can run the numbers for any situation, but they will probably say the same thing.

Call inflation 4%. Make the capital gains tax rate 8%. You still need a before-tax rate of return of 12.45% to get that inflation-adjusted after-tax bonus income of $37K.

In this scenario, inflation is more overwhelming than taxes. If you assume zero inflation, you only need a before-tax return of 8.35%. It's a real "tea leaves and entrails" prediction for what inflation will average for the next 20 years, but it is the major assumption and unknown in all of this.

This is all very interesting, but as the quote I posted shows, the most common way for winners to receive their jackpot (at least in Washington) is as a lump sum.

Seaboe

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Education is not the filling of a hard drive, but the lighting of a bulb. -- Yeats via Esprise Me

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BeachLife
The Bills of St. Mary's


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quote:
Originally posted by Hero_Mike:
quote:
Originally posted by Errata:
Capital gains aren't taxed at income tax rates, they're taxed at 8-10%. A progressive 30% capital gains tax would certainly inhibit investment, and not just for lottery winners. 2.5% inflation is below average for extended periods of time, and inflation doesn't work against the lump sum option, it works in favor of it. And the median family income in the US in 2005 was $60k.

I used the tax rates and income for a *single* person, simply because it includes fewer variables. I can run the numbers for any situation, but they will probably say the same thing.

Call inflation 4%. Make the capital gains tax rate 8%. You still need a before-tax rate of return of 12.45% to get that inflation-adjusted after-tax bonus income of $37K.

In this scenario, inflation is more overwhelming than taxes. If you assume zero inflation, you only need a before-tax return of 8.35%. It's a real "tea leaves and entrails" prediction for what inflation will average for the next 20 years, but it is the major assumption and unknown in all of this.

Jumping in a bit late, to point out that Mike's on the right track with this one. The prolonged payout is the better deal especially for the average person who will not invest the money wisely.

But even wise investments would require that one recoup the extra taxes they pay on the initial lump sum. Because of our progressive taxes with the lump sum you will pay the higest tax rate on most of the money. If you get $50,000 a year you will consistantly be paying less than the higest tax rate on the money.

Also keep in mind that if you decide to play the stock market, even in mutual funds, there is no gurantee of returns at any rate. And there is a cost associated with moving your money out to and then back into liquidity. The average person simply doesn't have the discipline and financial sophistication to make a better go at the lump sum payment.

--------------------
Wisdom comes with age, but sometimes age comes alone.
Jack Dragon, On Being a Dragon
Confessions of a Dragon's scribe
Diary of my Heart Surgery

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Errata
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Hero Mike, I don't know where you're getting confused about inflation, but you're dead wrong about it. You keep adding it to the investment returns you need which is nonsensical. Inflation does NOT affect the returns you need on your investments for the lump sum, AT ALL. The only effect inflation has here is to reduce the value of the annuity.
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Bettie Page Turner
Happy Holly Days


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quote:
Originally posted by Errata:
quote:
Originally posted by Dr. Dave:
The Washington Post magazine had an indepth article about a winner in West Virgina. I have not read it in over a year, but IIRC, it lead to a broken community, dead granddaughter, etc.

quote:
Jack Whittaker's big Powerball win cost him -- and everyone around him -- dearly

Wow, thats an incredibly disturbing story. Its clearly about more than just the money though. All throughout the story it was clear that the whole regions poverty was a driving force behind all the conflicts. He could have handled things way better, but things wouldn't have turned so rotten if the community wasn't so desperate.

On the surface it is admirable to want to stay in your community, but at some point it does become destructive. He should have broadened his horizons beyond West Virginia. He could have kept a home and businesses there, and concentrated his charitable giving there since it needs it. But trying to live it up year round in an area that really doesn't have appropriate outlets for wealth is just going to cause trouble. He had access to plenty of places beyond his community where his excess wouldn't have been so disruptive.

Jack Whittaker had issues before he won. Just ask the folks in the community who weren't personally involved in the fiasco. (Somethign the article doesn't do much of.) He was certainly not regarded as the quiet, working-man winner hero that the article makes him out to be. Many folks around here just quietly rolled their eyes at the coverage as it unfolded. I really was amused by the part of the story talking about the second (SECOND!) time money was stolen from his vehicle. The authorities were saying it had to be an inside job, somebody who knew where his money was. Hell, the joke around here was that if you wanted money, just drive around the badlands (where the strip clubs are) until you see a black SUV with the keys inside. I think the article is a bit lopsided, and goes overboard on the "good ole country boy goes bad because of the god of money" angle. You'll find plenty of people who will state that Jack was a weenie with real problems way before the lotto. Doesn't make for as good a story though, does it? Look what happens when a good hick gets money. [Roll Eyes] Look, the guy was a cartoon from the very beginning. It's too bad what happened to his granddaughter, but the family was NFBSKed up long before Powerball.

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You fail to consider, for such is the tyranny of fashion, that the swan is not a slim animal... -Jincy Kornhauser, Melinda Falling

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BeachLife
The Bills of St. Mary's


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quote:
Originally posted by Errata:
Hero Mike, I don't know where you're getting confused about inflation, but you're dead wrong about it. You keep adding it to the investment returns you need which is nonsensical. Inflation does NOT affect the returns you need on your investments for the lump sum, AT ALL. The only effect inflation has here is to reduce the value of the annuity.

No, inflation reduces real value of the return on your investment as well. A $10,000 year return this year is worth much more than a $10,000 return in 2026.

--------------------
Wisdom comes with age, but sometimes age comes alone.
Jack Dragon, On Being a Dragon
Confessions of a Dragon's scribe
Diary of my Heart Surgery

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Griffin at the Maul
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Taxes on lottery winnings, according to :Motley Fool:
quote:
First, know that your lottery winnings are taxable. This is the case for cash winnings and for the fair market value of any non-cash prizes (e.g., a car or a vacation). Depending on your other income and the amount of your winnings, your federal tax bracket can go as high as 38.6%.

Your lottery winnings might also be subject to state income tax. Thus, depending on where you live, your total tax bill could exceed 50% You don't get any capital-gains rate break for lottery winnings, nor is there any income averaging to help lower your tax bill. In short, you're stuck.

Also:
quote:
If you win more than $5,000 in the lottery, 27% must be withheld from your winnings for federal income tax purposes. You will receive a Form W-2G from the payor showing the amount of lottery winnings paid to you during the year and the amount of federal income tax withheld. (This information also gets sent to the IRS.)
And finally:
quote:
If you are sharing the winnings, you could still wind up paying tax on the entire amount, depending on the sharing arrangement. The key is to establish that the assignment of all or part of a lottery ticket took place before you won. That is, if you simply win and then give away part of the winnings, you will be taxed on the full amount and will be treated as having made a separate gift (which, depending on whom you gave it to and the amount, could itself be subject to gift tax).


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Where are we going, and why are we in this handbasket?

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Errata
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quote:
Originally posted by BeachLife:
quote:
Originally posted by Errata:
Hero Mike, I don't know where you're getting confused about inflation, but you're dead wrong about it. You keep adding it to the investment returns you need which is nonsensical. Inflation does NOT affect the returns you need on your investments for the lump sum, AT ALL. The only effect inflation has here is to reduce the value of the annuity.

No, inflation reduces real value of the return on your investment as well. A $10,000 year return this year is worth much more than a $10,000 return in 2026.
And $37k in 2026 is worth much less than $37k in 2006. The point is that he has it ass backwards by making inflation a parameter that works against the up front payment, when it is in fact the PRIMARY reason that its worth considering the lump sum. It doesn't make sense to say that the investment has to be greater to account for inflation in order to compete with an annuity that is not scaled for inflation.
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Errata
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Griffin, what point were you trying to make with that? We all know that lottery winnings are subject to income tax.
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Hero_Mike
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Seaboe - I believe your cites, and I think that people take the lump sum because they are either older (i.e. someone over 60 is not likely to want to wait out 20 years to fully enjoy their money, because they are likely to be dead), or have immediate financial needs (like debt) that are best paid off today, taxes and discounting be damned! It still isn't the "best" option if inflation is low.

Beachlife - thanks.

Errata - your original point was that it was far better to take the lump sum (after the discount for annuity *and* the up-front taxes), and invest it.

Your first error is because you did not consider taxes on the investment earnings. My estimate of this rate was high (again, Canadian vs. US Tax law), but it is highly unlikely that you can get a 7% after-tax investment *without risk*.

You then mentioned inflation, and that 4% is a likely average over the next 20 years. So I incorporated inflation into my calculations. This is a little different than the original discussion.

So just to reiterate - if you make $40K per year, and then get another $50K per year in lottery winnings, you'll net $37K on the winnings. To keep up that same purchasing power, you have to inflate that $37K each year. Then I assume a 4% inflation rate and take the value of each of the 20 years of $37K+inflation payments and set up the collapsing sum.

You start with $372K, earn some interest, take some of the interest earnings away as taxes, subtract the $37K, and continue to the next year. The next year you earn interest and pay taxes at the same rate, but you deduct the $37K+4%. And so on. I can provide you with the spreadsheet very easily if you like.

--------------------
"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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Errata
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I'm not assuming you're investing the whole thing for 20 years before touching it, which is ridiculous. The invested figure was a ball park figure to demonstrate how inaccurate it is to take 20x the annual payment and compare it to the lump sum and say its "better", without taking into account inflation (which hurts the annuity FAR MORE than the lump sum) and compound interest.

quote:
Originally posted by Hero_Mike:
Your first error is because you did not consider taxes on the investment earnings. My estimate of this rate was high (again, Canadian vs. US Tax law), but it is highly unlikely that you can get a 7% after-tax investment *without risk*.

Its not an error, its simply beneath consideration. With capital gains tax rates, to get a 7% return after tax, you need less than 8% return before tax. Talking about a 7% return on investment is factoring in the rather negligible capital gains tax. That doesn't change anything.

The risk is short term. Over 20 years, making money is nearly inevitable. Look back over any 20 year period in the last 50, and there will be ups and downs, but you'll get a solid return at the end of the 20 years.
quote:
So just to reiterate - if you make $40K per year, and then get another $50K per year in lottery winnings, you'll net $37K on the winnings. To keep up that same purchasing power, you have to inflate that $37K each year. Then I assume a 4% inflation rate and take the value of each of the 20 years of $37K+inflation payments and set up the collapsing sum.

Thats a ridiculous way to calculate it. The 37K annuity you win IS NOT SCALED FOR INFLATION. The payments ARE NOT 37k+inflation, they are 37k. Its relatively less and less each year. The lottery doesn't care that that means you're losing purchasing power each year. If they were 37k scaled for inflation, then the annuity would be the hands down winner. But they're not, which is precisely why the lump sum in 2006 dollars is potentially better than the 37k in 2026 dollars.
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El Camino
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An annuity of $A/year lasting for T years, with payments beginning in one year, has a present value of:

PV = (A/r)(1 - 1/((1+r)^T))

where r is the "prevailing interest rate. Assuming your tax calculations are correct, the PV of $37K/year for 20 years at 5.36% (so r = 0.00536). Then

PV = $447,345.

That's not so much more than the $406,000 PV you get from the lump some. For many, the freedom allowed by the lump sum if worth the loss in value. Of course, for many the opposite is true, and the security provided by the annuity is a bonus for them.

I had always thought the lump sum was calculated so that the it was equal to the PV of the annuity stream - but that may be wrong and also may not take taxes into account.

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Errata
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quote:
Errata - your original point was that it was far better to take the lump sum (after the discount for annuity *and* the up-front taxes), and invest it.
Uh no, that was not my original post, in fact, unless you want to wildly mischaracterize it:

quote:
Originally posted by Errata:
quote:
Originally posted by Hero_Mike:
On the other hand, the $50K per year annuity should leave you with about $37K of after-tax income per year, which over 20 years, is the much better deal.

Maybe, maybe not. That $37k is worth less and less every year in real dollars due to inflation, while the lump sum is potentially earning interest over that time period. I suspect they work out to be pretty similar in real value on average.
You're the one who was talking about one being a much better deal. I was moderating your statement by saying its not that much better.

On my spreadsheet I have each person deduct X dollars to live on each year and invest the rest, then gain Y interest on their savings. In column 1, they start out with the lump sum, while in column 2 they get the annuity added each year.

In most cases their savings work out roughly the same after 20 years, though it does depend on the variables. I'm not saying lump sum is way better, but it gives you way more options and it can be managed in such a way that it gives you similar results.

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Hero_Mike
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*sigh* - alright then - let's make inflation zero.

We seem to be agreed that if you take the lump sum, your $1 million turns to $600K before taxes, and then $372K after taxes.

You were the one who pointed out that if you invested the *whole* of this $372K, after 20 years you would have $1.4 million with a return of 7%. That's great if you just want to use this as a retirement nest egg, but the more realistic situation is that the investment is a collapsing annuity with annual payments adjusted for inflation.

So running the numbers again, if you take the $372K up front, you need an 8.35% before tax annual rate of return to get 20 years of net $37K payments. This *is* a more reasonable expectation of what your investments can do during any 20 year period.

El Camino - your calculations are essentially correct, but if you check my link above for the US Federal tax rates, you see that the tax rate for income in the $40K range is 28%, and 35% for income above $326K. The PV of $1 million over 20 years at 5.36% is $600K, and about half of that is in this 35% tax bracket. Thus the roughly $70K difference in present value.

In any case, you can look at it this way.

Option 1 : Take the annuity - $50K per year (net $37K) for 20 years. Net income is $740K, taxes are $260K.

Option 2 : Take the lump sum of $600K. Pay $228K in taxes up front. Invest the $372K at 8.35% per year. Investments are taxed at 8% per year. Deduct a constant amount of $37K per year, not adjusted for inflation. After 20 years you have made a total of $400K in interest and paid $32K in taxes, realizing a net income of $740K. At the end of the day, your income *and* the government's income is the same. Except that in Option 2, the gov't gets their money up front.

YMMV, Errata, but you seem to think that investments, even over the long-term, are guaranteed and have very good returns. This is not the case. Just one or two bad years of low returns and high inflation can derail the option #2 scenario.

Remember that we are talking about a relatively small amount of money here. Winning $1,000,000 is not likely to make a huge impact on your life 20 years from now. It may help exactly at the right time - like when you are young and in debt from your schooling, or old and ready to retire.

My advice to people - look at your debts and "immediate" needs and then consider the options. If you are middle-aged and mortgage free, take the annuity and throw it into tax-sheltered retirement savings. Otherwise, take the lump sum because it's far better to pay off debt than risk it all on the stock market.

--------------------
"The fate of *billions* depends on you! Hahahahaha....sorry." Lord Raiden - Mortal Kombat

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Errata
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quote:
Originally posted by Hero_Mike:
YMMV, Errata, but you seem to think that investments, even over the long-term, are guaranteed and have very good returns. This is not the case. Just one or two bad years of low returns and high inflation can derail the option #2 scenario.

The whole point of long term investment is that one or two years of bad returns on well diversified investments will be counterbalanced by a recovery a few years down the road. People got terribly negative returns on the stock market earlier in the decade, but if they stayed in an index fund that whole time without panicking, they'd be way up. Thats how its worked for the past lifetime.

My spreadsheet had the amount taken out each year as a variable, not $37k, so at any value less than 37k, the annuity person was investing too. Spending only part of the money makes a huge difference. Assuming that you take 10% from your principal while earning 8% is not the best long term scenario, but its hardly your only option. That may not make sense for winning 1 million, but it does when you're talking about the general case of winning X million. If you win 10 million, you don't necessarily need 370k a year to live on. But since we both agree that 1 million isn't quit your day job money, then even at 1 million, it does make sense to consider scenarios where less than the full annuity is used for expenses.

You still don't understand the first thing about inflation, so give it up. Lottery annuities are not indexed for inflation in any way, so "one or two bad years of high inflation can derail" the option #1 scenario even worse than the option #2 scenario. Inflation is why you want to consider the lump sum, not an argument to be used against it.

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PhiloPharynx
I Saw Three Shipments


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Here's another point about investments. Why do companies offer annuities? To make money. They invest your money in various investments, take out their profits and taxes and then give you a set amount. They make money because they have professionals choosing good investments. Being rich, you can also hire professionals to do good investments and make the profit yourself. There are also many ways to reduce your tax burden. Yes, all investments have risk, which is why you diversify.
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