Just for fun ... the economics of winning the lottery

Posted Wednesday, March 28, 2012 in Analysis

Just for fun ... the economics of winning the lottery

by Gina Hamilton

The Mega Millions has reached $363 million, so a lot of you went out yesterday and bought a ticket. Or maybe many tickets. This is one of the situations in which, if you had enough money to buy every single combination, it might pay off. The odds are against you, of course ... you have one chance in 175,711,536 of hitting the Mega Millions.  However, since the payoff is $363 million, if no one else were to win it, you'd be better off than when you started. Of course, if you have $176 million floating around in liquid assets, you probably aren't playing the lottery anyhow.

But never mind. Let's assume that you won. Where would you even start?

Lump sum or annuity?

The first question they will ask you is whether you want the winnings in a lump sum or in an annuity. If you take a lump sum, you get considerably less than the $363 million.  According to the Mega Millions website, you would get $259 million if you took the lump sum. But hey, that's not pocket change either. If you took the annuity instead, you'd end up with a yearly draw of $38,500 per million for 26 years. A yearly income, then, would be $13,974,500. Not bad, either.  And you can hope that Mega Millions doesn't go bankrupt.

Most people, not too surprisingly, take the one-time, lump-sum payout. Other questions loom. Do you share with your brothers and sisters and children? Or do you help them in other ways later? But before you can think of any of that, you have to pay taxes.

Taxes

I think a case could be made for treating lottery winnings as a capital gain. After all, you invested in the ticket, and your investment paid off. Unfortunately, that is not how the federal government, nor the state government, will see it. Instead, they treat lottery winnings as earnings, and they are taxable at a not-inconsiderable 35 percent, federally.  In Maine, the highest marginal tax bracket is 8.5 percent. So in total, you will owe 43.5 percent on your winnings if you live in Maine. Even so, that leaves you with a princely $146 million, give or take. They will withhold some of this, but not nearly enough, so whatever you do, don't spend the tax money.

Now what?

OK, let's say you've stashed the tax money away and you now have $146 million. What do you do first? If you're like most of us, you add up your mortgage and car payments and credit-card debt and your kids' student loans and are shocked beyond measure when the total comes up to less than $200,000. The truth is, most of us have absolutely no idea how much $146 million is in spending money. But let's say you decide you're going to do all the wonderful things you always dreamed of ... trip around the world, brand new sailboat, new cars for the whole family, upgrade your camp by the lake ... whatever. Chances are high that after paying off all your debts, fulfilling your bucket list, and doing all those odd jobs around the house that never get done, you haven't even spent a million bucks. And you have to find a place to stash $145 million and change.

Getting help

You will need some important people in your life, immediately upon learning you are the big winner. You will need a tax attorney, an estate planner, and a personal banker. You'll also, sooner rather than later, need an investment counselor. You can't just heave $145 million into your checking account or credit union share account and leave it until you're ready for it. Most of it won't be insured, for one thing. Even if you don't want to do anything as drastic as invest the lot, you have to find a way to keep the money safe and secure until you know what you want to do with it. For a while, your banker will recommend that you put most of it in CDs or treasury bonds with a short-term maturity date ... say six months or a year. This is just to give you a breather, and to make sure you aren't so giddy with your winnings that you promise the earth to everyone you know.

Soon, you'll have to discuss who is getting some of your winnings. Most people establish trust accounts for the next generation ... this is something you can do without a huge tax penalty. College funds and, for special needs children, special needs accounts are important so that the kids have something from you that they can use as they grow up, but you or your designee hang on to the purse strings. You can help your older relatives, too, by setting up joint checking accounts or savings accounts. 

It is harder to help your brothers and sisters and cousins, but there are ways, and a good tax attorney can help with that. Your own children will be inheriting, so rather than trust accounts for them, establish allowances on which they will pay income tax but will not have to deal with a trustee. 

OK, let's say you've taken $20 million and set up your trusts and opened accounts for the older folks, and done what you can do without a blinding tax headache to help your brother and sister. You still have a fortune. Now you talk to your investment counselor. 

Invested very conservatively, your $125 million could yield you $3.75 million per year in income, and that WOULD be a capital gain, taxable only at 15 percent currently. 

Doing good

Many who end up with a fortune want to establish a foundation to help those less fortunate. We all have our ideas, and they're all good. But what you should do is work with someone who has been in nonprofits before. It's your money, the foundation bears your name, but you should not get down and dirty with the grantseekers. Set aside some reasonable sum as an endowment, discuss what you want the money to go for, and step away. Hire the best person you can to manage the fund, and leave him or her to it.

Planning ahead is the best strategy to deal with sudden wealth. If you don't have time to plan ahead ... and if you won last night, you don't ... you can still carefully keep your winnings safe while you do plan ahead. Just relax and enjoy the ride ... it's going to be fun.

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