Why Are Cash Values Lower?
Aug. 22, 2014 – With every big win comes a choice: cash or annuity? You’ll often hear of jackpot winners choosing the “cash option” for their prize, which is a much smaller payment than the number advertised in retailer windows.
Case in point: Kelsey Zachow, a 24-year-old single mom from Michigan, claimed her $66 million Mega Millions jackpot earlier this month. Zachow chose the $37 million cash option for her prize – only about 56 percent of the annuity prize she could have taken.
Naturally, many people wonder where the other 40-ish percent of the prize went. It’s doesn’t go to taxes, because cash prizes are still subject to state and federal taxes – Zachow received about $27 million after paying taxes on her cash prize.
It doesn’t line anyone’s pockets, it isn’t put back into the game, and cash values aren’t so much lower as a penalty for instant gratification.
In fact, that other 40-ish percent doesn’t really exist.
The cash value of a jackpot prize is all of the money the lottery collects from ticket sales. Winners who choose to take the lump-sum payment get all that money, minus taxes, and can do what they want with it.
Annuity prizes are “worth” more because the lottery takes the cash they have from ticket sales and invests it all at once – before taxes – and pays the interest gains back to the winner.
The annuity prize option could reduce the tax burden on jackpot winners, simply because they’re receiving less money over a longer period of time. However, a lot can happen in the 29 years it takes to collect a Powerball annuity prize.
Even though each check increases by 4 percent to keep up with inflation, most tax experts say taxes are likely to increase in the future as the government tries to whittle away the deficit.
A CBS News report from March 2013 comparing cash prizes to annuity prizes cited a Vanguard study, which showed that lump-sum investments generally bring better returns than annuities.
The study was careful to point out, however, that it all depends on the market when a big winner starts investing their new money.
And of course, it depends on the winner and what they choose to do with their windfall.
In the end, when you’re finally holding that giant check and trying to decide Cash or Annuity, it can all boil down to a fairly simple question.
Do you want a chance to invest your money and live off the interest, or would you rather have guaranteed income – by the millions – for 30 years?
And you thought picking the right numbers was hard.