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zzyzzx
@
2010 Aug 11, 3:46am
I would also take the lump sum, then do two chicks at once.
(obligatory Office Space movie reference).
SFace
@
2010 Aug 11, 10:43am
Let's look into the numbers,
500,000 pre-tax present value vs. 50,000 pre-tax annuity over 20 years, that is a discount rate of about 9%. It takes ten years to receive 500K and still have 500K left over a period of 20 years. 9% is signicantly above inflation and about twice the rate AAA rated bonds.
500,000 pre-tax lump sum, the bulk of it is in the 33% fed and 9.8% state tax bracket, I have no chance to keep a lot of money away from uncle Sam and auntie Sally. with the 50,000 installments I have a chance to at least shelter them into the lower tax brackets and allow inflation indexing to work it's magic on years income are light and/or semi retired.
I'll take the installments thank you. Most likely in real life, the discount rates is around 4.5% (or a lump sum value of around 650K which makes the decision more agonzing). There are ways to work around inflation hedge other than taking the lump sum (in your example) which seems to be a poor choice.
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Take the money in installments or take the money in a lump sum? Most people jump for the lump some option, but is it really all that good of a deal?
Say the lottery prize is 1 million dollars. If you take the lump sum, they will only give you half the amount before taxes. So that $500,000, with a 40% tax rate, that leaves you with $300000. Now if you take the 1 million dollars over 20 years, assuming a 40% tax rate (although I do believe it's lower) would yield you $30,000 a year, or $600,000 over 20 years. Now most people firmly believe they are financial wizards and could get a higher rate of return on there money there by turning there 300k into much more than the 600k if they invest wisely over 20 years.
And they would be right, but the old hard fact it most people are morons when it comes to investing. They buy when the stock is the "IN" stock and sell when everyone is bailing out of the market. They do the exact oppose of how your suppose to invest, they invest on Greed and Fear. We will also over look the obvious fact that if you got 300k, your not going to deposit the entire amount and invest it. Your going to spend it, 200k of it at least I'd say, your lucky if your going to have 100k left to wisely invest. Despite what the advisers say I think your far better off taking the money in installment than in a lump some.
Lets look at this another way, lets say the prize is 10,000,000 dollars, that gives you a 3 million dollar lump sum payout after taxes, or 300k a year for installments. You go hog wild and blow 1 million and invest the other 2 million. I predict that chances are your not going to earn 6 million dollars on that 2 million dollars by investing, the who people are morons when investing rule is going to come into pay and you'd be lucky to have anything left of that 2 million after 20 years.
Another thing I would like to point out is, buying 2 lottery tickets doesn't double your changes of winning the lottery. Some people believe if the odds of winning are 1 million to 1 and you buy 2 lottery tickets, your odds are now 500,000 to 1 and 4 tickets would be 250,000 to 1. This is just delusional. If you buy 2 lottery tickets, you have two shots of winning the lottery at the odds of 1 million to 1. Even if you purchased 500,000 lottery tickets, your not guaranteed a 50% shot at the price money, you have 500,000 chances at 1 million to 1 at winning the lottery. The only way those 500,000 tickets would translate into a 50% chance of winning if they were purchased in a way to cover the 500,000 possible combination's in the tickets. Even someone that purchased 1,000,000 random tickets isn't guaranteed to win, unless all the possible combination's are covered. Chances are the random tickets would cover somewhere around 60 to 70% of the possible combination's, with several repeats.