Lottery strategy or madness?
March 28, 2012 10:13 PM Subscribe
The current Mega Millions is valued at $500,000,000. I have (I think) a logical idea for the best way to maximize the "payment" option of the payout. More inside.....
You want a big pile of money, not 20 big-ish piles of money over 20 years.
I have a novel idea:
Instead of taking the 40% reduction for "lump sum", couldn't you get a very, very low interest (or flat-fee) loan from a large investment bank if you signed an agreement to have all payments made to them over the 20 year period?
As an example, I win the money, I take the payment option, I then sign a contract of some sort to have all payments diverted to the bank, and then the bank gives me $470,000,000. That's a six-percent return on a loan that is essentially guaranteed.
Also, wouldn't this be a better tax position than either the payment or lump sum?
My lady friend believes this is just silly and no bank in their right mind would take such a loan. Please settle this.....
You want a big pile of money, not 20 big-ish piles of money over 20 years.
I have a novel idea:
Instead of taking the 40% reduction for "lump sum", couldn't you get a very, very low interest (or flat-fee) loan from a large investment bank if you signed an agreement to have all payments made to them over the 20 year period?
As an example, I win the money, I take the payment option, I then sign a contract of some sort to have all payments diverted to the bank, and then the bank gives me $470,000,000. That's a six-percent return on a loan that is essentially guaranteed.
Also, wouldn't this be a better tax position than either the payment or lump sum?
My lady friend believes this is just silly and no bank in their right mind would take such a loan. Please settle this.....
This definitely exists. I often see TV ads for places that "buy periodic payments," whether lottery winnings or disability or whatever. Seeing as they advertise on TV, they probably aren't reputable, but real banks might do the same thing.
posted by drjimmy11 at 10:23 PM on March 28, 2012 [4 favorites]
posted by drjimmy11 at 10:23 PM on March 28, 2012 [4 favorites]
One issue would be: What happens if you pass away before the end of the payments? Are they transferable through a will and could the bank continue to collect?
posted by drjimmy11 at 10:25 PM on March 28, 2012 [1 favorite]
posted by drjimmy11 at 10:25 PM on March 28, 2012 [1 favorite]
In addition, the lump payment would be nowhere near that high. You have to account for inflation: $500mil today's dollars is not going to be worth $500mil in purchasing power in 20 years. Based on absolutely nothing, I'm thinking a lump sum payment would come out more like $200-250mil.
posted by drjimmy11 at 10:27 PM on March 28, 2012
posted by drjimmy11 at 10:27 PM on March 28, 2012
There was a This American Life that covered this a number of years ago. The interviewee had worked in the lottery annuity buyout industry and it didn't sound like something you wanted to get involved in if you could possibly help it. Who knows if more legitimate companies are also involved in this though. He had just written a book based on his experiances if you are interested.
posted by Medw at 10:30 PM on March 28, 2012 [3 favorites]
posted by Medw at 10:30 PM on March 28, 2012 [3 favorites]
Response by poster: I didn't think the whole "6% in one year vs. 6% over TWENTY YEARS" thing. It's late people.....
posted by lattiboy at 10:32 PM on March 28, 2012 [1 favorite]
posted by lattiboy at 10:32 PM on March 28, 2012 [1 favorite]
The Google will show you lots of institutions that do this stuff if you Google "lottery settlement." Just as with viatical settlements (life insurance and annuity settlements), people looking for money upfront on a long-term payout pay a lot for the privilege. Why? Because the settlement institutions can ask that much, and the people who want the money now will pay it.
posted by Sidhedevil at 10:32 PM on March 28, 2012
posted by Sidhedevil at 10:32 PM on March 28, 2012
Put another way, the last payment of, say, $25mil, which wouldn't be made until 2032, will by then only be worth $10-15mil or so in 2012 dollars. That's why the lump sum is so much less in the first place.
posted by drjimmy11 at 10:32 PM on March 28, 2012
posted by drjimmy11 at 10:32 PM on March 28, 2012
Response by poster: Okay, I know about the shady people who do the "lottery settlement" thing, but with this sum of money and a not desperate person with some kind of representation could a better deal be worked out through a valid bank?
Also, didn't take inflation into account.
posted by lattiboy at 10:36 PM on March 28, 2012
Also, didn't take inflation into account.
posted by lattiboy at 10:36 PM on March 28, 2012
Best answer: No. The lump sum payment is defined as the present value of the total prize. In other words, it's an amount such that if invested over the lifetime of the annuity payments would get you about $500MM. This is, of course, also just what you'd expect a bank to pay.
For example, the annuity period is 26 years. Let's ignore taxes and say the bank expects to earn 4% a year from your money. Then, other issues aside, they'd be willing to pay you about $180MM. The lump sum lottery payment works exactly the same way. The lottery is paying you the present value of $500MM, around that same amount.
posted by metric space at 10:44 PM on March 28, 2012 [7 favorites]
For example, the annuity period is 26 years. Let's ignore taxes and say the bank expects to earn 4% a year from your money. Then, other issues aside, they'd be willing to pay you about $180MM. The lump sum lottery payment works exactly the same way. The lottery is paying you the present value of $500MM, around that same amount.
posted by metric space at 10:44 PM on March 28, 2012 [7 favorites]
I bet you the 40% reduction for lump sum payout is pretty much exactly the equivalent you would get if you took inflation into account and offered a bank an acceptable amount of interest on their loan (don't forget they would want it to compound).
posted by lollusc at 10:44 PM on March 28, 2012 [2 favorites]
posted by lollusc at 10:44 PM on March 28, 2012 [2 favorites]
Best answer: could a better deal be worked out through a valid bank?
What's in it for them? They're not going to charge significantly less than a settlement company does out of the goodness of their hearts. Businesses charge what the market will bear, and it's pretty clear what the settlement market will bear.
posted by Sidhedevil at 10:44 PM on March 28, 2012
What's in it for them? They're not going to charge significantly less than a settlement company does out of the goodness of their hearts. Businesses charge what the market will bear, and it's pretty clear what the settlement market will bear.
posted by Sidhedevil at 10:44 PM on March 28, 2012
Inflation is irrelevant here. If I have $10 million dollars, and I invest in a 20 year annuity at a fixed interest rate, I would get the same amount of money back regardless of inflation.
So a government bond, for example, might pay 2% per year, or a corporate bond might pay 6% - they pay those same rates regardless of inflation, and inflation is part of the risk that gets weighed by investors.
In some cases, you can get bonds or other financial instruments that are tied to inflation.
You, not being desperate, are in a better negotiating position. The other problem is risk: The other party could default. So if you pay someone off who's getting payments for a lawsuit, you're taking on the risk that the other party might go bankrupt from the person who was getting paid. But that's a non-issue with the lottery.
An investment bank might be able to give you a better deal then the lottery, but i kind of doubt it. The whole point of being an investment bank is that they can earn really good interest on money.
So "present money" is worth more to them then it is to other investors -- that's why people invest with them.
What you might do instead is sell annuities directly to consumers. Setup a website and offer to pay people $X a year for $Y now, backed by your lottery payments. You may be able to get more money that way. Essentially you'd be selling a piece of your prize money to individual investors who are looking for a safe asset (Essentially, you'd be selling them a government bond, I guess)
posted by delmoi at 10:53 PM on March 28, 2012 [1 favorite]
So a government bond, for example, might pay 2% per year, or a corporate bond might pay 6% - they pay those same rates regardless of inflation, and inflation is part of the risk that gets weighed by investors.
In some cases, you can get bonds or other financial instruments that are tied to inflation.
They're not going to charge significantly less than a settlement company does out of the goodness of their hearts. Businesses charge what the market will bear, and it's pretty clear what the settlement market will bear.That's not true. They'll charge what they think they'll make money on. If the settlement industry charges high rates, its because their 'clients' are desperate.
You, not being desperate, are in a better negotiating position. The other problem is risk: The other party could default. So if you pay someone off who's getting payments for a lawsuit, you're taking on the risk that the other party might go bankrupt from the person who was getting paid. But that's a non-issue with the lottery.
An investment bank might be able to give you a better deal then the lottery, but i kind of doubt it. The whole point of being an investment bank is that they can earn really good interest on money.
So "present money" is worth more to them then it is to other investors -- that's why people invest with them.
What you might do instead is sell annuities directly to consumers. Setup a website and offer to pay people $X a year for $Y now, backed by your lottery payments. You may be able to get more money that way. Essentially you'd be selling a piece of your prize money to individual investors who are looking for a safe asset (Essentially, you'd be selling them a government bond, I guess)
posted by delmoi at 10:53 PM on March 28, 2012 [1 favorite]
Because it is late and I am silly, I worked out what interest rate you would need to get per year if you start with the lump sum payout, and then every year spend an amount equal to the per annum payout.
In order to still have enough to get your 20th per annum payout, assuming the lump sum is 60% of the jackpot, you would need to earn... 6% per year. (Actually 5.99962%, but who's counting).
This does *not* take into account inflation, I just assumed every year your final amount is
(amount at end of last year - per annum payment) Exp[x].
posted by nat at 10:53 PM on March 28, 2012
In order to still have enough to get your 20th per annum payout, assuming the lump sum is 60% of the jackpot, you would need to earn... 6% per year. (Actually 5.99962%, but who's counting).
This does *not* take into account inflation, I just assumed every year your final amount is
(amount at end of last year - per annum payment) Exp[x].
posted by nat at 10:53 PM on March 28, 2012
I should've also said that, if anything, you'll get a worse deal from a bank, as I illustrated above. The rate at which they're willing to loan you money will always be higher than a benchmark safe investment's rate of return, which is what the present value calculation will use.
posted by metric space at 10:55 PM on March 28, 2012 [1 favorite]
posted by metric space at 10:55 PM on March 28, 2012 [1 favorite]
Inflation is irrelevant here. If I have $10 million dollars, and I invest in a 20 year annuity at a fixed interest rate, I would get the same amount of money back regardless of inflation.
Inflation is relevant. If the payout dollars are worth 15% less in real terms then you'd best take that into account.
For a primer on all of this, read up on time value of money.
posted by Ironmouth at 4:59 AM on March 29, 2012
Inflation is relevant. If the payout dollars are worth 15% less in real terms then you'd best take that into account.
For a primer on all of this, read up on time value of money.
posted by Ironmouth at 4:59 AM on March 29, 2012
Best answer: Metric space is right. When you win the $500 million lottery, the lottery commission writes a check for the lump-sum amount, say $250 million. You can either take the check, or the lottery commission buys you an annuity with it. That annuity pays you $500 million over 26 years.
I doubt the lottery people haven't already arranged for the absolute cheapest annuity possible.
posted by gjc at 5:02 AM on March 29, 2012
I doubt the lottery people haven't already arranged for the absolute cheapest annuity possible.
posted by gjc at 5:02 AM on March 29, 2012
It isn't a 40% reduction. It is, as others have explained, simply the present value of the annuity. Right now, the reduction is right around 29%, because interest rates are so low.
Also: you're forgetting taxes. Here's the breakdown. With the lump sum, you pay your taxes all up front. With the annuity, you pay them over time. This will have a dramatic effect on your long-term earnings. Even taking the lump sum and investing all of it, you'd need to make at least 3%, probably closer to 5% if you did any investments with the annuity funds. This is doable, but by no means guaranteed. The market has been flat for the last decade.
posted by valkyryn at 5:44 AM on March 29, 2012
Also: you're forgetting taxes. Here's the breakdown. With the lump sum, you pay your taxes all up front. With the annuity, you pay them over time. This will have a dramatic effect on your long-term earnings. Even taking the lump sum and investing all of it, you'd need to make at least 3%, probably closer to 5% if you did any investments with the annuity funds. This is doable, but by no means guaranteed. The market has been flat for the last decade.
posted by valkyryn at 5:44 AM on March 29, 2012
valkyryn - the deceiving thing about the annuity number on the lottery site is that it doesn't figure in the time value of money and inflation effect on the 'after 26 payments' option. The total there is not directly equatable to the total of the single payment number.
Also, you could always invest wholly in tax-free municipal securities, and pull in 2-3% a year on the full amount tax free, which would net you a cool $5MM a year with no tax obligation.
At only 2% a year, you end up with $410MM tax free, as you've already paid all the state and federal taxes up front and now you are protected via tax-free bond, from any changes/increases in taxes (barring elimination of the tax free status). Now, that percentage rate still may not track well against inflation, but it still comes in more than the annuity that also ignores the time value/inflation issue.
posted by rich at 6:08 AM on March 29, 2012 [1 favorite]
Also, you could always invest wholly in tax-free municipal securities, and pull in 2-3% a year on the full amount tax free, which would net you a cool $5MM a year with no tax obligation.
At only 2% a year, you end up with $410MM tax free, as you've already paid all the state and federal taxes up front and now you are protected via tax-free bond, from any changes/increases in taxes (barring elimination of the tax free status). Now, that percentage rate still may not track well against inflation, but it still comes in more than the annuity that also ignores the time value/inflation issue.
posted by rich at 6:08 AM on March 29, 2012 [1 favorite]
valkyryn - the deceiving thing about the annuity number on the lottery site is that it doesn't figure in the time value of money and inflation effect on the 'after 26 payments' option
Yeah, but inflation applies regardless of whether or not you take it in a lump sum or over time. I'm not sure it matters one way or the other.
Also, you could always invest wholly in tax-free municipal securities, and pull in 2-3% a year on the full amount tax free, which would net you a cool $5MM a year with no tax obligation.
True, but again, you can do that with funds you get from the annuity too, and you wind up with more to invest that way. The up-front 25% tax hit is just massive. If I take $10 million out of the annuity payments every year and stick it in that same fund you're talking about, then over twenty-six years I'll have $83 million in tax-free interest, plus the $260 million in principle, for a cool $343 million in assets, on top of the $110 million in annuity income I didn't invest over that time. You're counting as if the entire lump sum was invested and reinvested with no expenses, so it's fair to count that in. With that, net over 26 years is right around $443 million.
posted by valkyryn at 6:39 AM on March 29, 2012 [1 favorite]
Yeah, but inflation applies regardless of whether or not you take it in a lump sum or over time. I'm not sure it matters one way or the other.
Also, you could always invest wholly in tax-free municipal securities, and pull in 2-3% a year on the full amount tax free, which would net you a cool $5MM a year with no tax obligation.
True, but again, you can do that with funds you get from the annuity too, and you wind up with more to invest that way. The up-front 25% tax hit is just massive. If I take $10 million out of the annuity payments every year and stick it in that same fund you're talking about, then over twenty-six years I'll have $83 million in tax-free interest, plus the $260 million in principle, for a cool $343 million in assets, on top of the $110 million in annuity income I didn't invest over that time. You're counting as if the entire lump sum was invested and reinvested with no expenses, so it's fair to count that in. With that, net over 26 years is right around $443 million.
posted by valkyryn at 6:39 AM on March 29, 2012 [1 favorite]
You can also support local organizations instead of big banks. Your concept was discussed at length by the media when Whitey Bulger won the lottery in 1991. Wikipedia does not have much info on it, but at the time, conventional wisdom was that he bought the ticket from someone who wanted a lump sum. He may have paid more than a bank would for cleanly laundered money.
posted by DaveZ at 11:19 AM on March 29, 2012
posted by DaveZ at 11:19 AM on March 29, 2012
If you win the lottery, be sure to find out what interest rate the lottery is using to figure the annuity. If they're assuming an unreasonably high return, that would influence the choice. People who win the lottery get lots of offers from investment groups and shysters to buy the annuity at a bargain. If you win the lottery, keep it a secret, if you possibly can. My lawyer had clients who won a several-million lottery, paid off the house, funded the retirement and college accounts, and kept it totally secret. Takes discipline, but would avoid a lot of aggravation.
posted by theora55 at 11:56 AM on March 29, 2012
posted by theora55 at 11:56 AM on March 29, 2012
gjc> When you win the $500 million lottery, the lottery commission writes a check for the lump-sum amount, say $250 million.
Incidentally, the calottery.com site is stating that the "estimated cash value" is $389.8 million. I am not sure if this is the lump sum that they would pay, but there you go.
posted by UrineSoakedRube at 12:44 PM on March 29, 2012
Incidentally, the calottery.com site is stating that the "estimated cash value" is $389.8 million. I am not sure if this is the lump sum that they would pay, but there you go.
posted by UrineSoakedRube at 12:44 PM on March 29, 2012
Unless I misunderestimate something, the tax on a lottery winning like that is going to be the top marginal rate of 35% whether it is pulled out one at the beginning or in 26 pieces. The 25% is just what they are required to take out by law.
So you don't save anything on taxes by splitting it out over time. (actually, you save a little bit because you get to take advantage of the lower tax brackets 26 times instead of just once. It amounts to about a half million over 26 years. Because the tax calculation for incomes over $379,150 is ($Income * .35) - $22,686.)
And that assumes taxes are going to stay the same for the next 26 years. Presumably, they aren't. If you think taxes will go down for people making ~$20 million a year, then the decision to take the annuity seems better. But if they are going to go up, better to pay the cheaper taxes now.
Yeah, but inflation applies regardless of whether or not you take it in a lump sum or over time. I'm not sure it matters one way or the other.
The difference is whether you get the opportunity to invest that money to counteract inflation, or the annuity company does. When they sell the annuity, they are effectively guaranteeing a rate of return. If they can invest that money and do better than their guarantee, they keep the money. If they do worse, they have to cough up the difference. The choice then becomes: "do I feel lucky? Can I invest better than they can?" Assuming the annuity company isn't stupid or corrupt, they will probably be making money. Why not invest yourself and keep that profit?
posted by gjc at 4:36 PM on March 29, 2012
So you don't save anything on taxes by splitting it out over time. (actually, you save a little bit because you get to take advantage of the lower tax brackets 26 times instead of just once. It amounts to about a half million over 26 years. Because the tax calculation for incomes over $379,150 is ($Income * .35) - $22,686.)
And that assumes taxes are going to stay the same for the next 26 years. Presumably, they aren't. If you think taxes will go down for people making ~$20 million a year, then the decision to take the annuity seems better. But if they are going to go up, better to pay the cheaper taxes now.
Yeah, but inflation applies regardless of whether or not you take it in a lump sum or over time. I'm not sure it matters one way or the other.
The difference is whether you get the opportunity to invest that money to counteract inflation, or the annuity company does. When they sell the annuity, they are effectively guaranteeing a rate of return. If they can invest that money and do better than their guarantee, they keep the money. If they do worse, they have to cough up the difference. The choice then becomes: "do I feel lucky? Can I invest better than they can?" Assuming the annuity company isn't stupid or corrupt, they will probably be making money. Why not invest yourself and keep that profit?
posted by gjc at 4:36 PM on March 29, 2012
theora55 writes "If you win the lottery, keep it a secret, if you possibly can. My lawyer had clients who won a several-million lottery, paid off the house, funded the retirement and college accounts, and kept it totally secret. Takes discipline, but would avoid a lot of aggravation."
If that even possible in a lottery of this type? Up here you are required to give permission to use your name and likeness in order to claim your prize and unlike a $2 scratcher the media and lotteries are going to publish your name far and wide if you win a huge prize.
posted by Mitheral at 5:41 PM on March 29, 2012
If that even possible in a lottery of this type? Up here you are required to give permission to use your name and likeness in order to claim your prize and unlike a $2 scratcher the media and lotteries are going to publish your name far and wide if you win a huge prize.
posted by Mitheral at 5:41 PM on March 29, 2012
Or, you could just wait until you actually win the lottery and hire an attorney and an accountant to figure all of this out for you. (You'll be able to afford them!)
posted by exphysicist345 at 6:46 PM on March 29, 2012
posted by exphysicist345 at 6:46 PM on March 29, 2012
Mitheral> If that even possible in a lottery of this type?
Not sure if there are differences from state to state, but metafilter's own Rogers Cadenhead mentions one instance from 6 years ago on his workbench.org site.
posted by UrineSoakedRube at 11:06 AM on March 30, 2012
Not sure if there are differences from state to state, but metafilter's own Rogers Cadenhead mentions one instance from 6 years ago on his workbench.org site.
posted by UrineSoakedRube at 11:06 AM on March 30, 2012
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posted by dfriedman at 10:15 PM on March 28, 2012