Wednesday came and went with no winner for the Powerball jackpot, which means the pot has now soared to $1.5 billion. The last time the 45-state lottery game’s winnings grew that high was in 2016 when the pot reached a world record $1.586 billion, a sum that was ultimately shared by three people.
If there’s a jackpot winner for the next drawing, which will take place this Saturday, the individual stands to pocket the second largest jackpot in Powerball history and the third-largest jackpot in U.S. lottery history, according to Powerball.
Americans love to spend money gambling. According to the latest data available from the Bureau of Labor Statistics, those between the ages of 65 and 74 spend the most on lottery tickets and betting pools. During the last quarter of 2017, individuals in this age range spent about $132 on tickets, while those 45 to 54 spent about $77.
What you’d earn if you put winnings in a high-yield savings account
To be clear, if there is one single winner of the $1.5 billion as a result of Saturday’s drawing, that does not mean the lucky individual will pocket all of that money. The one-time lump sum payment option for Saturday’s jackpot is $745.9 million.
If the winner chooses to take that payout, there would be a 37% federal tax bill to pay, which amounts to about $277 million in taxes, leaving the winner with about $473 million—before paying any state and local taxes.
By putting that money in our top pick for high-yield savings account, which offers a 4% APY, the interest that would accrue on $473 million would amount to about $18,920,000 annually.
It’s a financial move that lottery winnings expert Victor Matheson, Ph.D, an economics and accounting professor at College of the Holy Cross, strongly advises against. “That would be the worst possible thing you could do,” says Matheson.
There are several reasons why Matheson feels this way, most of which have to do with how little you’d earn on the money compared to other options and the tax benefits you’d be giving up to do this, which he explains in more detail.
Is putting your winnings in a high-yield savings account a good idea?
In short, no you should not deposit lottery winnings into a high-yield savings account.
Those lucky enough to hit the jackpot have a choice when it comes to distribution of the windfall. The money can either be paid in lump sum as already described—or through 30 years worth of annual annuity payments, Matheson explains. In the case of the current Powerball jackpot, the annual annuity payments for $1.5 billion would amount to about $50 million per year for 30 years.
If you opt for yearly payouts, the lottery will take the bulk of the money you just won and invest it in a very conservative annuity, which will earn about 4.5%. That’s higher than what the best high-yield savings accounts are offering right now. And your annual $50 million payments will come from that fund.
“So by taking the annuity, it is basically like having the lottery put your money into a high-yield savings account in the first place,” Matheson explains.
But here’s the kicker—and why it makes far less sense to take a lump sum payout and put the money in a high-yield savings account: By choosing annual annuity payments, you avoid paying a 37% federal tax bill on the full $745 million, Matheson explains. Instead, you pay taxes once a year on the $50 million payouts.
“You get to defer your taxes with the annuity in a way, because you don’t have to pay all of the taxes up front like you do if you take a lump sum and go put it in a high-yield savings account yourself,” says Matheson. “If you take the money now in a lump sum, you get the tax hit up front.”
That’s a $277 million federal tax bill versus paying about $18.5 million annually in taxes on your $50 million yearly distributions. “From a purely financial standpoint, the advantage of taking the annuity is you don’t have to pay taxes on winnings until you actually receive the money,” Matheson continues. “You’re getting a bunch of money that’s earning money for you and the taxes are deferred. It’s not like it’s tax free, but you don’t have to pay taxes on that final annuity payment for 30 years.”
Separately, if you choose to put that $50 million annual payment in a high-yield savings account, you would earn about $2,000,000 each year. But none of this is to say annuity payments are the only option.
High-yield savings account versus investing in the stock market
While a high-yield savings account may not be the wisest financial move you can make with millions of dollars in lottery winnings, there are other choices. Yet another scenario for your winnings is investing the money in the stock market.
If you opt for a one-time, lump sum distribution, pay your tax bills on the winnings and invest the money yourself, you could invest it far more aggressively than the lottery would.
“I don’t mean putting the money into junk bonds, or Tesla or tech or forex,” says Matheson. “I mean putting it into broad-based index funds, like any S&P 500 index fund. In that scenario, you take the tax hit up front, but in the long run, index funds average 7% to 8%, so you’re likely to come out ahead over time. But you have to invest aggressively.”
Doing the math on that investment approach, Matheson calculates that you stand to make somewhere in the neighborhood of $40 million annually, assuming 8% earnings on an investment of $472 million.
What to do if you win the lottery
Deciding what to do if you win the lottery is, of course, a very personal choice. And to be clear, the odds of winning are slim—about 1 in 292 million in fact.
Of those who do beat the odds and win, about 99% opt to take the lump sum payment, says Matheson. So what to do if you find yourself in those lucky shoes and are suddenly faced with such a dilemma? Do you take the money all at once? Take annuity payments? Invest it aggressively? Here are some do’s and don’ts to consider:
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Don’t take a lump-sum payout and put it in a high-yield savings: If you choose to take a lump sum, Mathseson advises against parking it in a high-yield savings. “If all you’re going to do is put it in safe, conserve state and federal bonds or a high-yield savings, under no circumstances should you take a lump sum payout, because the lottery association will do that for you and you get to defer all of that taxation,” advises Matheson.
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Assemble a team of advisors. For most of us, a lottery windfall is more money than we’ve ever had to handle. Put together a top-notch team of trustworthy, well-vetted advisors who can help. This should include a lawyer and a financial expert. “Seek professional and legal advice immediately upon winning this or any other lottery award,” says Matheson.
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Develop a plan. Think carefully about your goals for the money and develop a plan that includes both short and long-term priorities. Your plan might also encompass charitable giving and other priorities such as travel or paying for educational expenses for your children.
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Establish a budget. Even as a millionaire, it’s important to manage money wisely. Have your team of experts help develop a budget that covers day-to-day expenses as well as annual expenses like property taxes, and don’t forget your tax bills. If you choose annuity payments, you’ll need to pay the annual tax bill on that income.
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Invest wisely. Whether you take a lump sum or annual annuity payments, it’s a good idea to invest some of that money in a well-diversified portfolio of common debt and equity mutual funds, with an emphasis on index funds, says Matheson. “Stay away from individual business deals for things like franchises or small businesses or venture capital until you know what you are doing,” he says.
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Establish an estate plan. Finally, be sure to think carefully about how the winnings will be handled in your passing. “Have a very clear and explicit will with appropriate estate planning,” says Matheson.
This story was originally featured on Fortune.com
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Source: finance.yahoo.com