Time Value Of Money And The Real World

If you win the lottery, would you take the annuity payments or a lump sum? The South Carolina winner of the $1.537 billion Powerball jackpot chose the lump sum distribution of $878 million. The annuity option would have been an immediate payment, with 29 more annual payments increasing at 5 percent per year. The first analysis is typically to calculate what rate is being offered, but we need to know the first payment amount to calculate the rate. However, real world factors, like income taxes and estate taxes, complicate the decision. The current income tops out at 37 percent, but some in Congress have argued that the top tax rate should be 90 percent, so the future income tax rate could be much higher, making the lump sum distribution even more valuable. Additionally, if the winner dies before all the annuity payments are made, whoever inherits the remaining payments would be responsible for estate taxes on these future payments immediately, not when the payments were made. In short, if you win a big lottery jackpot, we recommend you contact a lawyer and/or tax advisor because the decision is not as simple as a time value of money decision.